Taxability of 401(k) distributions after retirement

After I retire and start to draw money out of my 401(k), some of that money represents my original contributions (the rest is employer contributions and capital gains).

Does the tax code specify which withdrawals are treated as original contributions, therefore non-taxable, vs. fully taxable? Or can I decide?

Do I need to consult a tax specialist when the time comes?

401(k) contributions are tax deferred, that is, you didn’t pay tax on your contributions when you put the money in the plan (your pay stubs should reflect this). All withdrawals will be taxable.

Recently, the Roth 401(k) was created, in which the money you put in the plan has already been taxed. This was only available in the last couple of years, so I doubt that is what you have. But in this case, all withdrawals are tax free.

I’m sure someone who knows more will be along soon.

Dag is correct. Generally your contributions are taken off of your taxable income at the time you make the contribution. This means that all withdrawals will be taxed as ordinary income as none of the money has been taxed yet.

There are some 401ks that allow after tax contributions, in which case the portion representing return of your after-tax contributions would not be taxed. This is relatively rare however, and almost certainly didn’t happen if you were not a high dollar contributor to the plan. If you did make after-tax contributions, let me know and I can go over how that works.

Including long term capital gains in your 401(K), or is that treated differently?

You’re taxed on the amount you withdraw, not that it is a long term or short term capital gain. You don’t have to worry about capital gains when you withdraw from a retirement plan. You’ll be taxed as ordinary income.

I should mention that there is a little known but very important tax provision called ‘Net unrealized appreciation’ that applies separately to any company stock you hold in your 401k. For people who hold stock in their own company it can save a ton if you structure the transaction correctly.

Which means at current rates that you could pay up to 35% federal income tax on the capital gains versus the 15% you would pay on gains outside the 401(k). Because of this, some advisors suggest that you use your 401(k) for investments that yield income-taxable income (e.g. bonds) and other vehicles for capital gains. Note - this is only relevant if you have a lot more to invest than can be accommodated in a 401(k) - you should not stack your 401(k) with bonds if it is your only investment vehicle as that will not give the long-term growth you would be looking for.