Ordinary Income Taxation
One of the biggest drawbacks to a 401(k) plan is related to taxes — even though tax advantages are often cited as among the biggest benefits of a 401(k). It’s true that you can make pretax contributions that grow tax-deferred within the account. But the problem lies when you actually withdraw your money. Everything that comes out of a 401(k) plan is taxed as ordinary income unless it is rolled over into another qualifying plan within a certain amount of time.
This is true even if the bulk of your profits have come from capital gains, which is often the case in a 401(k) plan. If you are in one of the higher tax brackets, this means you might end up paying much more than the current capital gains tax rate of 15% when you take money out of your account in the form of a distribution.
