How does 401(k) withdrawal affect taxes?

The majority e-mails and letters I receive from readers focus on saving for retirement.

Specifically, many of you have questions about 401(k) plans.

I guess that's no surprise, what with baby boomers hitting retirement age in mass numbers, a nationwide housing downturn and continuing stock market volatility.

So for the next two columns, I will focus on a couple of reader questions regarding 401(k)s.

This week's question came from a reader named Greg. I chose to answer his first, because I think he's got a great first name.

"If I am over 59 1/2 and not working, and I decide to withdraw from my 401(k), does that 'income' affect my tax bracket for that year?" Greg asked in an e-mail. "In other words, I'm told that an advantage of the pretax investments from a 401(k) is that I may likely be in a lower tax bracket at time of withdrawal. If that withdrawal is significant, won't it put me in a higher tax bracket for that year, and then I'll have to pay a higher tax percentage on the withdrawal?"

Good questions, Greg. For help with answers, I contacted Jeff Salisbury, principal at Independent 401(k) Advisors, a fee-only advisory firm with offices in Cache and Davis counties.

First, regarding your tax bracket, Jeff says the answer to your question is "absolutely yes."

"That money that is withdrawn from a 401(k), not a Roth option, and a traditional (individual retirement account) is treated in the year you withdraw it as income, exactly as if you earned it," Jeff says. "So it's additive to any other income you may have earned this year, and it absolutely has the chance to push you into a higher bracket."

That means tax considerations are tremendously important when you are mulling withdrawals from your 401(k). But there are things you can do to lessen those concerns.

"The Roth option ... would not present a problem like that," Jeff says. "A Roth 401(k) or Roth IRA does not present you with the same challenge on the back end, because with a Roth, you pay taxes when you put money in, but not when you take the money out. That's reversed from a traditional IRA and traditional 401(k)."

If he could wave a magic wand, he says, he would encourage people to put half of their retirement investments in each kind of account.