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.{¹} Two significant exceptions exist: qualified Roth 401(k) distributions are not taxed, and certain government retirees covered by the Bailey Settlement pay no state tax on their retirement benefits at all.

How the Tax Is Calculated

North Carolina builds its individual income tax on top of your federal return. The state starts with your federal adjusted gross income and then applies its own additions and deductions. Because the IRS counts traditional 401(k) distributions as ordinary income, the full withdrawal amount flows straight into your North Carolina taxable income. There is no separate state form for the distribution itself; you report and calculate the tax on Form D-400.{²}

The 2026 rate of 3.99% is down from 4.25% in 2025.{¹} A quick example: withdraw $50,000 from a traditional 401(k) with no other North Carolina adjustments, and you owe roughly $1,995 in state income tax on that distribution. Federal income tax comes on top of that, based on your bracket.

Roth 401(k) Distributions

Qualified Roth 401(k) distributions are not taxed by North Carolina. The reason is mechanical rather than a special state exemption: qualified Roth distributions are not included in your federal adjusted gross income, and since North Carolina builds its calculation on federal AGI, nothing enters the state equation. You paid income tax on the contributions going in, so contributions and earnings come out tax-free at both levels once you satisfy the age and five-year holding requirements.

A non-qualified Roth distribution is a different story. If you take money out before age 59½ or before the five-year clock runs, the earnings portion gets added to your federal AGI and taxed by North Carolina at the standard 3.99% rate.{¹}

The Bailey Settlement Exemption

A court-ordered exemption known as the Bailey Settlement can wipe out North Carolina income tax on qualifying government retirement benefits. It 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.{³}

Eligibility hinges on a specific date. 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.{⁴} For the state’s 401(k) and 457 plans, you qualify if you had contributed or contracted to contribute before that date.{⁵}

When you qualify, your entire benefit from the qualifying plan is exempt from North Carolina income tax, no matter the size of the distributions or your other income. The exemption also carries through to beneficiaries who inherit a qualifying Bailey account.{⁵} To claim the deduction, enter the excludable amount on Line 20 of Form D-400 Schedule S and attach Federal Form 1099-R. Keep employment records and retirement system statements documenting your pre-1989 vesting; the Department of Revenue can ask to see them.

Private-sector 401(k) plans do not qualify for Bailey, no matter how long you worked for the employer or how much of that work happened in North Carolina. Retirement benefits earned as a teacher or state employee of another state also do not qualify.{⁵} If you worked for a private company and contributed to a traditional 401(k), your distributions are fully taxable at 3.99%.

Bailey Rollovers to Roth Accounts

Rolling funds from a qualifying Bailey account into a Roth account triggers federal tax on the rollover, but North Carolina exempts it. You deduct the rollover amount on your state return, and later qualified distributions from the Roth account are generally not taxable at either level.{⁶}

Early Withdrawals Before Age 59½

Pulling money from a 401(k) before 59½ triggers the federal 10% early withdrawal penalty on top of regular federal income tax.{⁷} Because the withdrawal still hits your federal AGI, North Carolina also taxes it at 3.99%.{¹}

The stacking adds up. On a $10,000 early withdrawal, you would owe $1,000 in federal penalty, federal income tax at your marginal rate, and roughly $399 to North Carolina. For someone in the 22% federal bracket, that single $10,000 distribution can cost over $3,500 in combined taxes and penalties before counting the lost future growth.

Federal exceptions can waive the 10% penalty in specific situations, 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 regular federal and state income tax on the distribution.

Moving Out of North Carolina

Federal law blocks states from taxing retirement income of former residents. Under 4 U.S.C. § 114, only your current state of residence can tax your 401(k) distributions, even if you funded the account entirely while working in North Carolina.{⁸} If you move to a state with no income tax, your distributions avoid state tax entirely. The protection covers 401(k), 403(b), and IRA distributions.

Update your address with the plan administrator promptly after you move. Otherwise the administrator may keep withholding North Carolina tax, and you would have to file a state return to claim the refund.

Part-Year Residents

If you moved into or out of North Carolina during the tax year, you file as a part-year resident. The state taxes income you received while a resident, plus any North Carolina-source income received while a nonresident.{⁹} A 401(k) distribution received after you moved out generally would not be North Carolina-source income, so timing matters. Part-year filers complete Form D-400 Schedule PN to calculate the taxable percentage.{¹⁰}

Inherited 401(k) Distributions

If you inherit a 401(k), the distributions 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 to you as beneficiary.{⁵}

The federal 10% early withdrawal penalty does not apply to distributions paid to a beneficiary after the account holder’s death, regardless of the beneficiary’s age.{⁷} You still owe regular federal and state income tax, but the 10% is off the table.

Withholding on Your Distribution

Plan administrators required to withhold federal tax on a distribution paid to a North Carolina resident must also withhold state income tax. Lump-sum and other nonperiodic distributions carry a required state withholding rate of 4%. For periodic payments such as monthly pension checks, the administrator withholds as if you were a married filer claiming three allowances, unless you file Form NC-4P with different instructions.{¹¹}

You can elect out of state withholding on most distributions by filing the appropriate form with your administrator. Eligible rollover distributions are the exception. If you take a check instead of doing a direct rollover, withholding is mandatory.{¹¹} Opting out of withholding does not reduce what you actually owe. You just pay it when you file, and if the underpayment is large enough, interest can apply.

1
NCDOR. Tax Rate Schedules
2
NCDOR. North Carolina Individual Income Tax Instructions
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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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NCDOR. PD-14-1 Bailey v. State of North Carolina
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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