• How and when are you taxed on your money?

• When do you pay taxes on IRA and 401k funds?

How and when are you taxed on your money?

A 401k is a great tax deal, but you will have to pay the tax man eventually. Calculate how much you'll save in taxes with a 401k. Because you don't pay taxes on the money you put into the plan, you pay when you take withdrawals from it. Withdrawals from 401k plans are often called "distributions." Your 401k money can be withdrawn without penalty after age 59 1/2, and you must begin to withdraw money annually from your account no later than April 1 of the year following the year in which you turn age 70 1/2.
If you're over age 59 1/2, distributions are taxed this way:

• For pre-tax contributions: both the contributions and the investment earnings are treated as income.

• For after-tax contributions: the contributions are treated as a nontaxable return of capital, but all investment earnings are treated as income.

It depends on what kind of plan you have. Basically, these plans defer income taxes, but they do it in various ways. Sometimes contributions are deductible, and sometimes not. Earnings in the plans are not taxed until withdrawal. Even though investments usually are sold when a withdrawal is made, no capital gains taxes are due, only income taxes. The exception is the Roth IRA, in which you pay no taxes on accumulated earnings at any time. The chart below summarizes the rules:

You can roll over a 401k directly to an IRA without paying taxes when you leave your company. You also can convert an IRA to a Roth IRA, but you must pay taxes on all contributions and earnings at that time. The government has laid some land mines to possibly boost taxes on these plans. If you withdraw funds before you are 59 1/2, you may be liable for a 10% early withdrawal fee. On the other end, you must start withdrawing funds at age 70 1/2 or you will face another penalty. If you withdraw more than $150,000 a year or a one-time lump sum of $750,000, you will pay another 15% penalty.