401(k) Taxation

• 401(k) plans are established under Section 401(k) of the Internal Revenue Code. Neither employee contributions nor employer contributions are subject to federal income tax. All contributed funds plus any earnings on those funds are subject to federal income tax only when the participant withdraws funds from the plan.
  
  

Gains and Losses

• When an employee’s contributions gain or lose value, an unrealized gain or loss occurs. The gain or loss is realized only when the investment is sold. The funds from the sale of the investment will remain in the 401(k) plan. No federal capital gains tax is assessed on any capital gains. Income tax is assessed on the overall value of the plan, not on individual securities, and only at the time of withdrawal.
  
  

Reporting

• Wages that are directed to a 401(k) plan as pre-tax contributions are not included on the Form W-2 issued by the employer, and these funds are not reported on the employee’s income tax return. Any withdrawals made from a 401(k) plan by a participant must be reported as taxable income on the individual’s Form 1040 income tax return on the pensions and annuities line item.
  
  

Withdrawals

• Withdrawals made before age 59-1/2 are subject to federal income tax as well as a 10-percent penalty. Taxes and penalties do not apply if the withdrawal is rolled over into another 401(k) or IRA account within 60 days of the date of withdrawal. Withdrawals made after age 59-1/2 are subject only to federal income tax on the withdrawn amount.