Ask the Knowledgeable: What are the foundations for taxing IRA withdrawals

I’ve heard conflicting information about withdrawals from 401(k) accounts. I’m 66 years old. I know at 72 I’ll need to take required minimum distributions from my account. I’d like to take some money out earlier. I’ve read that with the new tax law I can take out up to $20,000 and not pay federal and New York State taxes. If filing a joint return, I can take to $40,000. Is this correct?

No. You’ve been misinformed.

First things first. Are you still working for the employer who sponsors your 401(k) plan? If you’ve left that job, you can withdraw as much as want from your account. If you’re still working for that employer, does the 401(k) plan allow “in-service” withdrawals? If it does, you can take a withdrawal now. And since you’re over 59½, you won’t incur any early withdrawal penalty.

But either way, the withdrawal won’t be tax-free.

Assuming your 401(k) contributions were untaxed, all your withdrawals are federally taxable. The $20,000 tax exclusion you’ve heard about isn’t new. It’s a long-standing New York law that applies only to state income taxes.

State residents who are over 59½ get a tax exclusion on up to $20,000 of annual income from their tax-deferred retirement accounts. For example, if eligible, you can take $8,000 from a 401(k) plan and $12,000 from IRAs, and the entire $20,000 is state tax-free.

But each New York taxpayer qualifies for this exclusion as an individual. This means you can only claim it on distributions from your own retirement accounts. Together, two spouses can potentially exclude $40,000 if each qualifies to claim a $20,000 exclusion on withdrawals from his/her accounts. But if Joe takes only $5,000 from his accounts, he can’t pass his unused $15,000 exclusion to Betty.

The bottom line

401(k) withdrawals aren’t tax-free.

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