Tax day 2018 is just around the corner! We have two extra days this year — the deadline is Tuesday, April 17th (Update: the deadline is now actually April 18th, due to issues with the IRS website on the 17th!). As you’re gathering your tax forms for this year, you’ll most likely run into a W-2 for income from an employer or a 1099-INT for interest income from a bank, brokerage firm, or financial institution.
Since one of the immediate tax advantages of owning a 401(k) lowering your taxable income, you may wondering what form you’ll need to attach to your return and how to report any 401(k)-related numbers on your 1040. Let’s review different scenarios for 401(k) plan holders and the necessary action items for each one of them.
Case #1, the most common: No distributions (withdrawals) from a 401(k)
Here’s some great news for the bulk of retirement savers: if you haven’t made any withdrawals from your 401(k), then you don’t need a special form from your 401(k) provider and you don’t need to report anything to the IRS. This is an incentive from Uncle Sam to keep your contributions untouched until retirement age.
Per IRS guidelines, your employer doesn’t include your pre-tax contributions in your taxable income and reports your contributions on boxes 1 and 12, respectively, of your form W-2. While your contributions aren’t subject to federal withholding, they are subject to withholding for Social Security and Medicare taxes. In the case of a Roth 401(k), you contribute with after-tax dollars. So, your employer would include your contributions in box 1 from your W-2.
Whether you own a traditional or Roth 401(k), as long as you didn’t take out any distributions, you don’t have to do a thing on your federal or state return!
Note about potential state tax forms: As more and more states are rolling out their state-sponsored retirement savings plans in 2017 and beyond, you may have to do some kind of paperwork with your state government in future years. While you may opt out from these state retirement plans due to personal choice or existing ownership of an employer-sponsored 401(k), you’ll have to very likely notify you State Treasury in some way. Keep up with the latest developments in your state.
Case 2: You separated from an employer
You may have separated from your employer because you were laid off, let go, or quit. Depending on the rules and features of the employer-sponsored retirement plan from your previous employer, you may have left your contributions untouched, cashed out your account, or completed a direct or indirect rollover. Here are the reporting repercussions for each one of these scenarios.
Case 2a: You left contributions in the plan from previous employer
If this is the case, you have nothing to report to the IRS just like in the first case that we reviewed above.
However, plan holders with balances under $5,000 should make sure to leave instructions to their former employers to leave the monies in the plan as is. According to a Plan Sponsor Council of America survey of 613 plans with 8 million participants, 57% of 401(k) plans with balances between $1,000 and $5,000 are forcefully transferred to an IRA of the plan’s choosing when the owner of the 401(k) doesn’t indicate what to do after separation from employment.
Case 2b: You (or your employer) cashed out your 401(k)
The same survey indicates that over half of employers cash out employee accounts with balances under $1,000. Or you may have decided to cash out some or all of your nest egg. Unless you were to roll over those monies to a new account (more on that in just a bit), you would receive a 1099-R from your employer (as long as your balance was at least $10).
Your employer would indicate the taxable amount from your gross distribution on box 2a, indicate any capital gains on box 2b, and generally withhold 20% of your cashout in federal taxes on box 4 of form 1099-R.
You would use your 1099-R to calculate your taxable income and report your withheld federal taxes in the appropriate places of your 1040. Individuals under age 59 1/2 need to use part one of form 5329 to calculate the applicable extra 10% in early distribution tax. Roth 401(k) holders under age 59 1/2 are also subject to the 10% tax when taking distributions.
Case 2c: You completed a direct rollover
If you completed a direct rollover (monies were directly transferred from your previous plan to your new plan) for the full amount of your 401(k), then you don’t have to do anything at all. You’ll still receive a 1099-R from your previous employer but the form will indicate that your gross distribution isn’t subject to taxes. If you left a portion out of the rollover and kept it, then you’ll have to pay applicable taxes on that portion.
When the rollover is to an IRA, then the plan admin of the IRA needs to provide you a form 5498 as proof that your monies were used to fund an IRA and aren’t subject to taxes.
Case 2d: You completed an indirect rollover
In an indirect rollover, you received a cashout check from your previous plan but were able to find a new qualifying plan within 60 days. In this case, the IRS will use your 1099-R from your previous employer and the W-2 from your new employer (or form 5498 from your new IRA) to cross reference the indirect rollover on your 1040.
When doing an indirect rollover, you have two options. Let’s go over them, assuming that your employer cashed out a $1,000 balance from your 401(k).
- You decide to rollover the $800, but not the mandatory $200 (20%) withheld by your employer: You’ll claim the $800 as non-taxable income and the $200 as taxes paid. If you were under age 59 1/2, you would need to file form 5329 to calculate the early distribution tax of 10% on the $200, unless you’re eligible for an exception.
- You choose to rollover the entire $1,000 balance: Since your employer withheld $200, you’ll need to come up out of your own pocket with the $200 to fully fund a nontaxable rollover of $1,000. You’ll claim $1,000 as non-taxable income and the $200 as taxes paid.
Here are additional resources on completing rollovers:
Depending on your unique situation, you may need to file additional forms. It’s a best practice to keep records of all communications with your previous and current plan admins as evidence of a rollover. Consult your tax planner or accountant for more details on how report your direct or indirect rollover.
Case 3: You have an outstanding 401(k) loan
There are many reasons why it doesn’t makes sense to take a loan from your 401(k). Here’s one more: you can’t deduct the interest payments that you make on your 401(k) loan. This means you won’t receive an interest statement like the one you receive when paying mortgage interest (Form 1098).
As long as you keep up with your agreed payment schedule and you pay your loan in full within five years (or within 60 days when separating from your employer), you won’t have to do anything special on your taxes. However, defaulting on your loan turns the remaining unpaid balance into a taxable distribution and triggers the same rules described under case 2b above. Even worse, you are no longer eligible to do an indirect rollover and are likely to trigger additional penalties from your plan and state government.
Case 4: You’re retired or age 70 1/2 and over
Once you’re retired or reach age 70 ½, you’ll have to start taking required minimum distributions (RMDs) from your traditional 401(k) or Roth 401(k). In these cases, you’ll have to consult the appropriate IRS distribution worksheets to determine your RMD starting on April 1st of the year after you retire or turn age 70 1/2.
It’s very important that you meet your RMDs because you would owe a 50% federal penalty tax on the difference between the amount you withdrew and the amount you should have withdrawn. To report that penalty tax, use form 5329.
One way to avoid having to take RMDs once you reach age 70 1/2 is to complete a rollover (as described in case 2c above) from your previous 401(k) to a new employer-sponsored 401(k) and continue working, even on a part-time basis. Holders of Roth 401(k)s trying to follow this advice need to rollover to a new Roth 401(k) or Roth IRA. If you’re trying to do complete this late rollover option, you can’t hold more than 5% of the company sponsoring the original traditional or Roth 401(k).Age 70 1/2 isn’t the only age to think about retirement, here’s a list of other Critical Milestones and Ages on Your Path to Retirement.
The bottom line
As a general rule, most 401(k) retirement savers don’t have to do anything special on their taxes and most retired 401(k) plan holders have to do something for their taxes. However, defaulting on your 401(k) loan, cashing out some or all of your balance, and completing a partial rollover will require to do some legwork on your return. When doing any of these, make sure to get your ducks in a row and prevent an IRS penalty.
One quick way to know if you have triggered any forms that you require for your return is to check the tax statement section of the online portal of your 401(k) throughout the first quarter of every year.
Recommended reading: Why You Should File Your Taxes Early