How a 401(k), pension, or IRA payout is taxed depends on three questions: Is the money pre-tax or Roth? How old are you? How does it come out of the account? Pre-tax money is taxed as ordinary income when you take it. Taking it before age 59 1/2 usually adds a 10% penalty. Michigan changes the picture for 2026: the state’s retirement subtraction is fully phased in, so most retirees can subtract eligible retirement income up to a set maximum no matter what year they were born. Early distributions do not qualify. Our guide to the Michigan retirement income deduction for 2026 covers the state side in detail. This page covers the mechanics once, in plain terms, and points you to deeper pages where they exist.
Traditional (pre-tax) 401(k). You didn’t pay income tax on the money when you put it in, so you pay it when you take it out. The withdrawal counts as ordinary income in the year you take it, taxed at your regular bracket. Your plan reports it to you and the IRS on Form 1099-R.
Designated Roth 401(k). You paid tax on the money going in, so qualified withdrawals come out tax-free. A distribution is qualified when the account has been open for at least five taxable years and you are at least 59 1/2, or when you die, or when you become disabled. A withdrawal that is not qualified can be partly taxable. A Roth 401(k) also has no required minimum distribution for you while you are alive.
For context, the 2026 limits are:
These are contribution limits, not withdrawal limits. They matter here because contributions are what build the balance you will eventually be taxed on. (Source: IRS announcement of 2026 retirement plan limits.)
Withdrawals also aren’t always available when you want them. Whether you can withdraw money from an employer plan while you still work there depends on your plan’s terms, so ask your plan administrator before you count on it.
Where IRAs fit. The same pre-tax versus Roth split drives how an IRA payout is taxed, and the early withdrawal penalty and required minimum distribution rules below apply to IRAs as well. The main difference is the list of penalty exceptions, which is slightly different for IRAs than for employer plans (see the table in the penalty section).
Questions to ask before you take money out. A few minutes with your plan administrator can prevent most surprises:
A pension is a monthly payment from a plan your employer funded. If you never made after-tax contributions, every payment is fully taxable. If you did, part of each payment is a tax-free return of your own money, figured under the Simplified Method for pensions that started after November 18, 1996. Your payer reports the payments on Form 1099-R.
Pension payers withhold tax based on Form W-4P. If you owe at filing time year after year, update that form so more is withheld. For how retirement changes your overall tax picture, see how your taxes change after retirement. (Source: IRS Topic 410, Pensions and annuities.)
If you take money out of a 401(k), pension plan, or IRA before age 59 1/2, the IRS generally adds an additional 10% tax on top of regular income tax. You report it, or claim an exception, on Form 5329. For more on how this plays out in real situations, read our page on early withdrawals from retirement accounts.
The penalty has exceptions. Which ones you can use depends on the type of account:
Qualifying for an exception removes the 10% penalty. It does not remove the income tax. Exceptions are not applied automatically, either. Your plan or IRA custodian puts a distribution code on Form 1099-R, and if the code does not show the exception you qualify for, you claim it yourself on Form 5329. The same code also matters in Michigan, as explained below. (Source: IRS exceptions to the early distribution tax.)
An illustrative example. Say you are 45 and withdraw $20,000 from a traditional 401(k), and the extra income is taxed at a 22% federal rate:
Your plan will likely withhold 20%, or $4,000, before you ever see the money (more on that below). Federal withholding doesn’t cover the federal tax and penalty of $6,400, and it doesn’t cover Michigan, so you could still owe about $3,250 at filing time. Examples are illustrative, and every case turns on its own facts.
When an employer plan pays you an eligible rollover distribution directly, it must generally withhold 20% for federal income tax. That is why a $20,000 withdrawal can arrive as a $16,000 check. The withholding is a down payment against your tax, not the tax itself.
A direct rollover avoids the withholding. If you move the money straight from your plan to an IRA or another employer plan, nothing is withheld, and nothing is taxed. If the check is made out to you instead, you generally have 60 days to deposit it into a new account to avoid tax on the rolled-over amount. To make the full amount whole, you would need to replace the 20% you withheld out of pocket.
Hardship distributions, required minimum distributions, and substantially equal periodic payments cannot be rolled over. (Source: IRS Topic 413 on rollovers.)
A hardship withdrawal from a 401(k) is taxed like any other distribution: ordinary income, and the 10% penalty unless an exception applies. Because you can’t roll over a hardship distribution, you cannot undo the tax by redepositing it. If you are wondering how closely the IRS looks at these withdrawals, we answer that in IRS audits of hardship withdrawals.
You cannot leave pre-tax money in a retirement account forever. Once you reach age 73, you must start taking required minimum distributions (RMDs) from pre-tax accounts, and each one is taxed as ordinary income. Your first RMD is due by April 1 of the year after you turn 73. Missing an RMD triggers a 25% excise tax on the amount you should have taken, reduced to 10% if you correct the shortfall within two years. A designated Roth 401(k) has no RMD for the owner while living. (Source: IRS required minimum distribution rules.)
Michigan’s individual income tax rate for 2026 is 4.25%.
The retirement subtraction is fully phased in. Under Public Act 4 of 2023, the Michigan retirement subtraction rose to 25% in 2023, 50% in 2024, and 75% in 2025, and reaches 100% for 2026 and later. For 2026, regardless of the year you were born, you can subtract eligible public and private retirement benefits, combined, up to the inflation-adjusted private retirement maximum. That maximum was $65,897 for single filers and $131,794 for joint filers in 2025. The 2026 amount is adjusted for inflation, and Michigan Treasury had not published the 2026 figure when this page was updated. Check Treasury’s retirement guidance or the 2026 instructions for Form 4884 for the current number. The subtraction is a maximum on combined benefits, not a separate cap for each source, so a pension, an IRA payout, and a 401(k) distribution all count toward the same limit. (Source: Michigan Treasury Revenue Administrative Bulletin 2026-1.)
Early distributions do not qualify. A distribution coded 1 on Form 1099-R (an early distribution with no known exception) is not eligible for the Michigan subtraction, so it is taxed at 4.25%. A normal distribution (code 7) or a disability distribution (code 3) generally qualifies. (Source: Michigan 1099-R distribution code guidance.)
401(k) distributions can qualify. Some 401(k) distributions are eligible, and the rules depend on whether the money comes from employer contributions or from contributions the plan required of employees. If you are unsure whether your distribution qualifies, have a preparer review it against the bulletin above.
Social Security. For tax years 2026 to 2028, Michigan Public Act 24 of 2025 allows taxpayers born after 1952 who are 67 or older to claim both the Social Security deduction and the full standard deduction ($20,000 single, $40,000 joint). For how federal collection interacts with benefits, see Social Security and the IRS.
Florida. Florida has no personal income tax, so Florida doesn’t tax these distributions. Federal tax still applies.
Withholding is an estimate, and it often falls short, especially after an early distribution. If you took a distribution and the tax bill is bigger than you expected, start by filing accurately. Reporting the distribution correctly and claiming any exception you qualify for on Form 5329 can lower what you owe. If you still cannot pay in full, you have payment options, and filing on time matters even when you cannot pay. See our page on help with a tax bill from a distribution for how the process works.
Do you pay taxes on 401(k) withdrawals?
Yes, for a traditional (pre-tax) 401(k): the withdrawal is ordinary income in the year you take it. Qualified distributions from a Roth 401(k), after the five-year period and age 59 1/2, are tax-free.
What is the penalty for early 401(k) withdrawal?
A 10% additional tax on top of regular income tax if you are under 59 1/2 and no exception applies. Common exceptions include leaving your job in or after the year you turn 55, disability, and certain medical expenses.
Does Michigan tax pensions and 401(k) income in 2026?
For 2026, the retirement subtraction is fully phased in: regardless of birth year, you can subtract eligible retirement benefits up to the inflation-adjusted private maximum ($65,897 single / $131,794 joint was the 2025 figure). Early distributions without an exception are not eligible.
How are pensions taxed?
Federally, pension payments are fully taxable unless you made after-tax contributions, in which case part of each payment comes back tax-free. Use Form W-4P to set withholding so you do not owe at filing time.
Why was 20% withheld from my 401(k) distribution?
Employer plans must withhold 20% of an eligible rollover distribution paid to you. A direct rollover avoids withholding, and 20% may not cover your full tax bill if you also owe the 10% penalty.
If a retirement distribution left you with an unexpected tax bill, or you want a preparer to review your return before you file, Levy & Associates can help with retirement income tax preparation and resolving a balance you already owe. Our attorneys, Certified Public Accountants, Enrolled Agents, and former IRS Revenue Officers handle federal matters, and our Michigan-licensed attorneys handle Michigan Department of Treasury matters.
Call 248-557-4048 for a confidential conversation or contact us online.
Levy & Associates handles civil tax matters only and does not represent clients in criminal tax matters of any kind. This page is general information, not legal, tax, or employment advice. Reading it does not create an attorney-client relationship. Prior results do not guarantee a similar outcome. Examples are illustrative, and every case turns on its own facts. No outcome is guaranteed.
Levy & Associates is available for free initial consultations. We’re happy to answer any questions you have about the audit process or address any concerns about your specific situation.
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