Earnings on 401(k) aren’t capital gains

Two letters to the editor referencing 401(k) and capital gains have some misconceptions. According to the IRS, a 401(k) is a tax-qualified deferred compensation plan in which an employee can have the employer contribute a portion of his or her cash wages to a plan on a pre-tax basis. Employer 401(k) plans are not capital gains. An IRS penalty of 10 percent additonal tax is assessed if an individual withdraws their funds before the age of 59 1/2 years old.

Those who have a 401(k) plan expect to earn money on it, but it is not capital gains. The same IRS 10 percent penalty is assessed on tax-deferred Individual Retirement Accounts.

Capital gains is the difference between what a person pays for a financial asset and what he sells it for. For instance, buy a house for $100,000, sell it in 15 years at $175,000. The capital gain is $75,000. Buy stock in a company at $100 per share, sell 10 years later at $190 per share, capital gains is the difference between the buy price and the sell price multiplied by the number of shares a person sells. Take the same house at $100,000 and sell for $90,000 you now have a capital loss. For capital gains/losses it is necessary to file a Form 8949 along with Form 1040 at tax time. No so with 401(k) accounts.

Elizabeth Phillips