Are 401k Losses Tax Deductible?

  • The tax rules for 401(k) plans can be confusing and sometimes contradictory.
  • Under the Internal Revenue Code, you generally cannot deduct losses incurred in your 401(k) from your taxable income.
  • There are some exceptions to this rule, however.

The tax rules for 401(k) plans can be confusing and sometimes contradictory. Under the Internal Revenue Code, you generally cannot deduct losses incurred in your 401(k) from your taxable income. There are some exceptions to this rule, however.



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How Does a 401k Plan Work?

The 401k plan, originally named Employee Retirement Income Security Act of 1974, is a retirement savings plan that allows employees to save money for retirement on a pre-tax basis. Plan participants can set up automatic deductions from their paychecks and invest the money in a stock market index fund, bond fund, or a mix of the two.

The Start-Up

In spite of being one of the most valuable employee benefits, the 401(k) is often underutilized. The 401(k) is much more than a tax-advantaged retirement account.
In a 401(k) plan, the maximum amount you can contribute to your account is $19,000 in 2022. If you're 50 or older, you can contribute an additional $6,000 as a "catch-up" contribution. All salary deferrals (as well as employer contributions) are tax-deductible. Employees have the option of fully pre-taxing money that they contribute to the 401(k).



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The Business

IRS rules allow 401k losses to be deductible against net capital gains and ordinary income, but not against net short-term capital gains.
Some employers make up for the lack of tax deductions by matching 401k contributions, usually dollar for dollar up to a maximum limit.

Retirement Plans

If you are saving for retirement in a plan such as a 401(k), your contributions, and earnings, are tax deferred until you withdraw the funds. This means that you don't pay income tax on the income in the plan each year.
If you have a traditional 401(k), any contributions you make are deductible, as are any contributions made by your employer. Traditional 401(k) plans are also eligible for pre-tax contributions.
If you have a Roth 401(k), you may contribute after-tax money, but tax-free withdrawals are possible after age 591⁄2.

Other Retirement Accounts
If you are saving for retirement in an IRA or other tax-advantaged retirement account, you do not have to pay taxes on contributions or earnings, regardless of when you start taking withdrawals.

are 401 k losses tax deductible

IRS Rules for Retirement Plans

The IRS has strict rules regarding 401k withdrawals. Some 401k plan administrators may allow participants to take a lump sum withdrawal or withdraw from specific funds without a penalty. Additional withdrawals should be made by April 15 of the following year. If a participant is younger than 59 and a half years old, there is a 10 percent penalty on the total amount withdrawn.



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The Bottom Line

A 401k can be a great retirement tool, but for most investors, the potential for a loss may outweigh the tax benefits. Know the tax implications of a 401k before you decide to invest.
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