Does North Carolina Tax 401(k) Distributions?

Yes, North Carolina does tax 401(k) distributions. Traditional 401(k) withdrawals are treated as ordinary income and taxed at the state’s flat rate of 3.99% for the 2026 tax year, down from 4.25% in 2025.¹ Two meaningful exceptions apply: qualified Roth 401(k) distributions escape state tax entirely, and certain government retirees qualify for the Bailey Settlement exemption that wipes out North Carolina tax on their retirement benefits.

How the Tax Is Calculated

North Carolina builds its income tax on top of your federal return. The state starts with your federal adjusted gross income, applies its own additions and deductions, and taxes the result at the flat rate. Because the IRS treats a traditional 401(k) distribution as ordinary income, the full withdrawal already sits inside your federal AGI by the time it reaches your state return. There is no separate state-level step for the distribution itself.

You report everything on Form D-400, the state’s individual income tax return.² A quick example: if you take $50,000 from a traditional 401(k) and have no other North Carolina adjustments tied to that income, the state tax on the withdrawal is roughly $1,995. That sits on top of whatever federal tax your bracket produces.

One thing North Carolina does not tax is Social Security. If any portion of your Social Security benefits is included in your federal AGI, you deduct that amount on your state return so it drops out of your North Carolina taxable income.³ For many retirees, that leaves the 401(k) as the only retirement income the state actually touches.

Roth 401(k) Distributions

Qualified distributions from a Roth 401(k) are not taxed by North Carolina, for the simple reason that they never enter your federal AGI. You already paid income tax on the contributions, and once you meet the age and five-year holding rules, both contributions and earnings come out federally tax-free. Nothing from a qualified Roth distribution shows up in the state calculation.

Non-qualified Roth distributions work differently. If you pull money out before age 59½ or before the account has been open five years, the earnings portion gets included in federal AGI, and North Carolina taxes that portion at 3.99%.¹

The Bailey Settlement Exemption

A court-ordered exemption known as the Bailey Settlement can eliminate North Carolina income tax on certain government retirement benefits. The exemption is written into the tax code at G.S. 105-153.5(b)(5) and covers distributions from federal, state, and local North Carolina government retirement plans.⁴ Private-sector 401(k) plans do not qualify, no matter how long you worked for the employer.

To be eligible, you must have been vested in your government retirement plan as of August 12, 1989. For defined benefit plans like the Teachers’ and State Employees’ Retirement System or the Local Governmental Employees’ Retirement System, vesting generally required five years of creditable service.⁵ For the state’s 401(k) and 457 plans, you qualify if you had contributed or contracted to contribute to the plan before that date.⁶

If you qualify, your entire retirement benefit from the plan is exempt, regardless of how large the distributions are or how much other income you have. The exemption also extends to beneficiaries who inherit a qualifying Bailey retirement account.⁶

To claim the deduction, enter the excludable amount on Line 20 of Form D-400 Schedule S and attach Federal Form 1099-R. The Department of Revenue can request documentation proving your vesting date, so hold on to employment records, retirement system statements, and any service-credit letters from before the 1989 cutoff.

The Bailey exemption does not reach retirement benefits from private-sector employers, and it does not cover benefits paid to former teachers or state employees of other states.⁶ A private-sector 401(k) is fully taxable at 3.99% with no Bailey deduction available.

Early Withdrawals Before Age 59½

Pulling money out of a 401(k) before age 59½ triggers the federal 10% early withdrawal penalty on top of regular federal income tax.⁷ North Carolina still taxes the full withdrawal at 3.99% because it is sitting in your federal AGI.

On a $10,000 early withdrawal, that works out to $1,000 in federal penalty, federal income tax at your marginal rate, and roughly $399 in state income tax. For someone in the 22% federal bracket, the single withdrawal can cost over $3,500 in taxes and penalties before you count lost future growth.

Several federal exceptions can waive the 10% penalty, including permanent disability, certain unreimbursed medical expenses above a percentage of AGI, and separation from service after age 55.⁷ Even when the penalty is waived, you still owe federal and state income tax on the distribution.

If You Move Out of North Carolina

Federal law prohibits states from taxing retirement income once you no longer live there. Under 4 U.S.C. § 114, only your current state of residence can tax your 401(k) distributions, even if every dollar in the account was earned while you worked in North Carolina.⁸ If you move to a state with no income tax, the distributions escape state tax entirely.

Update your address with the plan administrator as soon as you move. If the administrator still has you listed in North Carolina, it may keep withholding state tax, and you would then need to file a North Carolina return to claim a refund.

If you moved into or out of North Carolina during the year, you file as a part-year resident. The state taxes income you received while you lived there and any North Carolina-source income you received as a nonresident.⁹ A 401(k) distribution received after you moved out generally would not count as North Carolina-source income, so the timing of the withdrawal matters. Part-year filers use Form D-400 Schedule PN to work out the share of total income subject to state tax.¹⁰

Inherited 401(k) Accounts

Distributions you take from a 401(k) you inherited are generally included in your federal AGI and taxed by North Carolina at 3.99%. The important exception is Bailey: if the original account holder was vested in a qualifying government retirement plan before August 12, 1989, the exemption carries through to you as beneficiary.⁶

The federal 10% early withdrawal penalty does not apply to distributions paid to a beneficiary after the account holder’s death, no matter the beneficiary’s age.⁷ Regular federal and state income tax still apply.

What Gets Withheld From Your Distribution

When a plan administrator has to withhold federal tax on a distribution paid to a North Carolina resident, it also has to withhold state income tax. For lump-sum and other nonperiodic distributions, the required state withholding rate is 4%. For periodic payments such as monthly pension checks, the administrator withholds as if you are a married filer with three allowances unless you submit Form NC-4P with different instructions.¹¹

You can elect out of state withholding on most distributions by filing the right form with your plan administrator. The exception is eligible rollover distributions paid directly to you: if you take a check instead of completing a direct rollover, withholding is mandatory.¹¹ Opting out of withholding does not reduce what you owe. It only shifts payment from the moment of distribution to filing time, and if you underpay through the year, you can face underpayment interest.

1
NCDOR. Tax Rate Schedules
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NCDOR. North Carolina Individual Income Tax Instructions
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NCDOR. Social Security and Railroad Retirement Benefits
4
North Carolina General Assembly. North Carolina Code 105-153.5 – Modifications to Adjusted Gross Income
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My NC Retirement. Qualifying for Benefits
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NCDOR. Bailey Decision Concerning Federal, State and Local Retirement Benefits
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Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
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Office of the Law Revision Counsel. 4 USC 114 – Limitation on State Income Taxation of Certain Pension Income
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NCDOR. Individual Income Filing Requirements
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NCDOR. 2025 Part-Year Resident and Nonresident Schedule D-400 Schedule PN
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NCDOR. Directive PD-00-2