California state tax withholding for ira distributions

Employees in California have multiple options when it comes to saving for retirement. Along with a 401(k), if employers offer such a retirement program through company benefits, there is also a state-sponsored retirement program that has begun rolling out over the past few years. Learn more about 401(k) options, opportunities to save with the state-sponsored plan, and other must-know information about preparing for a California retirement.

As an employer, before you go with a state-run retirement plan, there are a few things to consider.

What is a 401(k) in California?

A 401(k) is a tax-qualified plan that allows employees to withhold a portion of their pay on a pre-tax basis. With these funds, employees can choose among a range of investment funds at various levels of risk. These plans are intended to help employees save long-term for their non-working years. 401(k) contributions are limited to an annual maximum dollar amount, as outlined by the Internal Revenue Code (IRC). Employers may choose to make a matching 401(k) contribution, which is typically a percentage of employee contributions, up to a certain portion of the total salary, or a profit-sharing contribution. Contributions into a 401(k) plan grow tax-free until retirement, when distributions are treated as taxable income.

Employees in California should strongly consider taking advantage of saving in a 401(k) plan, if their employer offers this benefit. With traditional pensions continuing to disappear, inflation rates continually on the rise and the state's high cost of living, workers in California and nationwide face a significant retirement savings burden. Starting to save sooner rather than later can put you in a more financially stable position as your golden years approach.

What are the benefits of a 401(k) in California?

A 401(k) can be one of the best tools for helping your employees save for retirement. Not only that, but there are also many advantages for you, as an employer, to sponsor a 401(k) plan:

• It increases your company's attractiveness in the job market.
• It can positively impact your worker retention efforts.
• It offers the business-tax-savings opportunities, if you offer a company match to participating employees. Matching contributions are tax-deductible, up to applicable Internal Revenue Service (IRS) limits.
• You and other company leaders can participate in the plan.
• It can be relatively straightforward to administer, particularly if you work with a payroll services provider that allows you to automatically transfer participants' contributions into the 401(k).

For employees, benefits of a 401(k) include:

• The ability to place money into a 401(k) plan tax-free, which lowers their taxable income.
• Having a say about how much they want to contribute, which can be helpful for workers at different stages of their retirement savings. A 401(k) calculator can help employees decide what they should contribute throughout their working years.
• Employees nearing retirement age, who are behind on saving, can take advantage of the ability to make catch-up contributions, which allow individuals age 50 or older to make additional contributions into their 401(k).

Are there potential penalties in California associated with a 401(k)?

Making early withdrawals from a 401(k) can result in penalties. If a 401(k) plan participant withdraws funds from their plan before age 59½, they would be subject to a 10 percent early withdrawal penalty from the IRS. In California, taking early distributions from a 401(k) also means incurring an additional 2.5 percent state tax. That means plan participants in California who make early withdrawals will pay a total of 12.5 percent in additional taxes for early withdrawals.

Example:

Shannon is 40 years old, lives in Sacramento and withdraws $10,000 from her 401(k) plan.

IRS early withdrawal penalty: $1,000

California tax on retirement income: $250

Net amount Shannon receives after paying California taxes and penalties: $8,750

Note that the CARES Act allowed 401(k) and Individual Retirement Account (IRA) plan participants to withdraw up to $100,000 from their accounts without penalty to pay for COVID-19-related costs. While the penalty was waived, these individuals will still be subject to taxes on these withdrawals, which they must pay within three years.

Does California tax retirement income?

As outlined in the example above, retirement account income — even if it isn't withdrawn early — is considered taxable income in California, including withdrawals from a 401(k), IRA and pension (government pension or private employer pension). Social Security benefits aren't taxed. Given that California tax rates are among the highest in the nation, along with the state's high cost of living, saving for retirement as soon as possible is strongly recommended for Californians.

• 401(k): Contributions are tax-deductible and withdrawals are taxed, in addition to any other taxable income.
• Traditional IRA: Contributions are tax-deductible, earnings grow tax-free and withdrawals are subject to income tax.
• Roth IRA: Contributions are not tax-deductible, and qualified withdrawals are tax- and penalty-free (both federal and California state taxes).
• Pensions and annuities: Per the IRS, the taxable part of a pension or annuity is generally subject to federal income tax withholding. You may be able to choose not to have income tax withheld from your pension or annuity payments (unless they're eligible rollover distributions), or specify how much tax is withheld.

Can I use my 401(k) plan if I am unemployed?

If you're unemployed and meet certain criteria, you may not be subject to early withdrawal penalties. Workers age 55 to 59½ can access 401(k) funds only (not money in an IRA) without penalty if they are laid off, fired or quit. However, this only applies to assets in a current 401(k) plan (the plan owned by the employer where the employee was laid off, fired or quit). Money in a former 401(k) plan is not covered. This means the individual would have to wait until age 59½ to begin withdrawing from their entire nest egg without being assessed the 10 percent IRS penalty. Remember, regardless of when you take distributions from a 401(k) plan, California residents will also be taxed on this money.

Unemployed individuals can also receive substantially equal periodic payments (SEPP), a method of distributing funds from an IRA or other qualified retirement plan prior to age of 59½ without IRS penalty. This may be an alternative to claiming unemployment benefits, but these withdrawals will still be taxed as income.

Ultimately, however, any money you take out of a 401(k) or other retirement plan, regardless of the reason, will decrease the long-term value of your portfolio and set you back in your ultimate retirement savings goals. That's why drawing down from a 401(k) plan should be an option for true emergencies only.

Do withdrawals from a 401(k) affect unemployment benefits in California?

California looks at past earnings and requires unemployment applicants to meet certain minimum income thresholds to receive benefits from the state. Under California law, withdrawals from 401(k) plans count as income and may reduce an individual's weekly unemployment benefits.

My employer doesn't offer a retirement program

Research out of the University of California, Berkeley found that in 2019, six out of 10 private-sector employees in California worked for an employer that didn't offer a 401(k) plan, leaving many of the state's workers without a way to save for retirement at work.

That's why officials in California instituted the creation of CalSavers, a state-sponsored retirement savings program for businesses to offer employees. Private-sector businesses that meet certain criteria must offer the state-sponsored plan, which is set up as a Roth IRA, or establish a similar qualified retirement plan. The next deadline to register employees for the program or establish a plan, scheduled for summer 2022,& will require businesses with five or more employees to comply with the mandate.

When an employer registers the business, employees will be automatically enrolled into CalSavers. However, they can choose to opt out of and into the program at any point. If employees do not act within 30 days of notification once an employer registers for the program, they will be automatically enrolled at the default savings rate of 5 percent of gross pay.

Is my employer required to use the state-sponsored program?

Employers that meet certain criteria as outlined by the state must register for the CalSavers program by specified dates or offer their own employee retirement plan, such as a 401(k) or SIMPLE IRA, to satisfy this requirement.

CalSavers deadlines and requirements:

• Sept. 30, 2020 (passed): Businesses with 100-plus employees
• June 30, 2021 (passed): Businesses with 50-plus employees
• June 30, 2022 (passed): Businesses with 5-plus employees

Retirement plans that employers can offer that meet the state mandate include:

• 401(a)
• 401(k)
• 403(a)
• 403(b)
• 408(k)
• 408(p)
• 457(b)

What is the difference between a 401(k) and other retirement programs in California?

The chart below shows key differences between a state-sponsored IRA, a SIMPLE IRA, and 401(k) plan in California. Note certain factors, such as the availability of a company match, annual contribution limits, and the ability to receive employer tax credits. Administrative responsibilities are also a significant factor. A third-party administrator, like Paychex, can help employers with SIMPLE IRAs and 401(k) plans, whereas the responsibilities of a state-sponsored plan fall primarily to the employer.

*for eligible employers

Is there a minimum amount I need to contribute to a 401(k) plan in CA?

For employees, there is no minimum amount they need to contribute to a 401(k) in California, but there are maximum contribution limits as outlined by the IRS:

• 2022 maximum 401(k) contribution limit: $20,500
• Additional catch-up contribution for individuals 50 or older: $6,500

Choosing the right retirement plan

The ability to have access to retirement savings vehicles and contribute to them are goals that are becoming clearer for nearly all state residents considering California retirement. Whether an employer offers a 401(k) plan or institutes the CalSavers state-sponsored retirement program, employees across the Golden State should stay up-to-date on state retirement plans, and take advantage of options currently available to them. Employers should consider all types of plans before choosing a retirement program for employees, including industry-leading 401(k) plans and services that can help streamline plan management and control costs.

Are IRA distributions taxable in California?

Does California require state withholding on IRA distributions?

Are state taxes withheld from IRA distributions?

Is California a mandatory withholding state?