401k Distribution Penalty - Tax Gurus please help with the math

[Starbrite]

Can anyone give me ballpark numbers, and/or check my math, on how much it would cost to cash out a 401k? I am NOT, I repeat NOT, taking any money - just trying to show someone how I got my figures.

I understand it would cost thousands to even hundreds of thousands in the long run. But I'm talking right now, and on April 15th how much will it cost?

OK, with that said.....


Say you have an account balance of $34,000 - with an outstanding loan of $6,000 - Leaving about $28,000 available.

I figure they will hold 20% tax (based on the full $34,000) and 10% penalty correct? Leaving an actual cash out amount of appx $17,800

So the 20% is sent towards Income Tax withheld to the IRS correct? You owe anything over and above if you're in a higher tax bracket.
So say he makes $50,000 - usually gets about $5,000 refund. I figured it could end up being an amount due of $3,000 still on Tax Day.

Plus State & Local income tax on the full $34,000


End Result $34,000 in the 401k (Which could be inupwards of $150k at retirement) - Yields about $13k in pocket now (that includes setting aside the additional amounts for tax day)



Am I missing any other taxes or fees that need figured in?

 

[eliza61]

Not sure but I think also the money is considered income, so it could push you into a higher tax bracket come tax time.

 

[LadyBeBop]

In your case, there are a few missing variables...how many dependents you have, whether or not you itemize.

I calculated a ballpark scenerio in your case. Assuming you and your spouse file joint with no children. Total income of $50,000 and you take the standard deduction. I'm also assuming your normal refund would be $5,000. And that you would have 20% withheld from the pension for a net of $22,400 (withholding of $5,600). That is normal, and you'll still wouldn't have enough withheld.

Without the pension withdrawal, your tax would be about $3,700 on taxable income of about $30,500. You would be in the 15% tax bracket.

With the pension withdrawal, your taxable income would increase by $28,000 to $58,500. The tax would be about $7,900, an increase of $4,200. Fortunately, you would still be in the 15% tax bracket. The tax increase is about 15% of $28,000.

However, you would still be responsible for the 10% early withdrawal penalty, or $2,800.

The bottom line:

Additional tax plus penalty: $7,000.
20% Withheld on distribution: $5,600.
Difference: $1,400.

Your refund would be $1,400 less, assuming your normal refund is greater than $1,400.

Again, these are calculations based on assumed figures. They may change based on your deductions, your exemptions and your income.

HTH.

 

[manning]

Not sure but I think also the money is considered income, so it could push you into a higher tax bracket come tax time.

Yes, it will be considered as ordinary income and can push you into another tax bracket

 

[Cheshire Figment]

I'm not looking at the cash flow but the following:

1. The full $34,000 is considered taxable income to you. When you prepare you 2013 taxes that $34,000 will be included in your Gross, Adjusted Gross, and Taxable income.

2. Similarly, if you are in a state with an income tax the $34,000 will also be fully taxable income at your state rate.

3. As long as you are less than 59½ at the time you do the withdrawal (and do not meet a special exception) you will owe a penalty tax to IRS of $3,400.

4. At the time you do the withdrawal there will be the 20% withholding ($6,800) which will reduce your out-of-pocket payment to (or increase a refund from) IRS when you file your return.

Mike (CPA Retired but still doing taxes)

 

[DisneyBill]

I figure they will hold 20% tax (based on the full $34,000) and 10% penalty correct? Leaving an actual cash out amount of appx $17,800

I don't believe the 401k administrator will withhold the 10% early distribution penalty from the actual proceeds. The penalty likely will be calculated and included at the time of filing federal tax return. There is also a process that may help your friend who may be younger than 59.5 avoid the 10% penalty, something like a 72t rule that requires substantial withdrawals for five years.

 

[tvguy]

I don't believe the 401k administrator will withhold the 10% early distribution penalty from the actual proceeds. The penalty likely will be calculated and included at the time of filing federal tax return. There is also a process that may help your friend who may be younger than 59.5 avoid the 10% penalty, something like a 72t rule that requires substantial withdrawals for five years.

I'm not sure, best I can tell the 10% penalty is considered a tax, and the administrator is required to withhold all taxes before distributing the money.

 

[kcrew]

The 10% is definitely not withheld, a flat 20% is withheld. Also consider the $6000 loan will be converted to a distribution and NO withholding will have been taken on that portion. I am a tax preparer and if I had a dollar for every time I have heard "but they ALREADY taxed the distribution." No, they did withholding, just like they do from your paycheck. At tax time you settle up and the 20% is never enough once you factor in the 10% penalty off of the top (don't forget the $6000 loan conversion that had ZERO withholding), and then the regular tax. People that are entitled to credits such as EIC are also SHOCKED when they discover that such a distribution raises their income to a threshold that knocks them out of that credit, so it is not JUST the regular tax ramifications--it could snowball into the loss of thousands of dollars in credits. OH, and do not forget state taxes if you are from an income tax state--no withholding is done for the state, so in that case higher tax, no withholding an again the possible loss of credits as well. There are so many other possible scenarios as well, such as the effect of that increase in the yearly income when applying for any kind of financial assistance such as college. The ramifications can be DISASTEROUS!!!

 

[BuzznBelle'smom]

The only other thing I'll mention is that, since you'd only be withdrawing $28k, taxes would only be owed on that. As others have said, they withhold a flat 20%, and leave you to deal with the actual tax owed--the distribution is taxed as ordinary income, plus the 10% penalty owed on the $28k.

Assuming you still work for the company, you would continue making payments on the $6k loan, and eventually, all that money would be returned to the account. It would not be taxed, and would continue to grow until you took it out at some point in the future. Unless your plan is to cancel out this loan--I'm not sure how that would work. Then, you would owe taxes on the loaned money, as well.

While it gets confusing, it's good for you to check into this before you do it. I've heard of way too many people who are stunned to find out that emptying their nest egg didn't give them the financial boost they were looking for.

 

[ItsNotMuchofaTail]

I don't know a lot about taxes and 401k accounts as I don't have a 401k (I contribute to a defined benefit plan and a 403b), but my exSIL cashed out a substantial 401k and was SHOCKED at tax time that she owed thousands to the IRS. The 20% was taken at distribution, but the additional tax/penalty/ whatever was not. She was very foolish about the whole thing, it pretty much ruined her financially (but it was her own fault).

 

[Starbrite]

OP Here


Thank you all for the info. It has helped greatly!!!


I am strongly advising him NOT to do this. However, when you're left with no where to turn, and on the brink of losing your home & filing bankruptcy....I want him to be well informed of the consequences.


I wanted to be able to sit down & give him a roundabout number - when/if you do this, you need to immediately take $XXX and set it aside for tax day, do NOT touch it!

The form has an option for withholding the state income tax amount as well.


I plugged the numbers into a couple different tax programs & was able to get an estimate of the additional amount he will owe the IRS. (Obviously they are based on last years numbers so it will be a little different)



Thanks Again!!!

 

[disneysteve]

I am strongly advising him NOT to do this. However, when you're left with no where to turn, and on the brink of losing your home & filing bankruptcy....I want him to be well informed of the consequences.

Even facing foreclosure and bankruptcy, I wouldn't cash out the 401k unless he is absolutely sure he has fixed whatever issues put him in that situation in the first place. Otherwise he will end up losing the house anyway, filing bankruptcy anyway, and have lost his retirement savings.

 

[jedijill]

Retirement savings are protected in bankruptcy so absolutely don't cash out the 401k!!!! He should talk to a BK attorney for a free consultation before he makes any decisions at all even if he doesn't actually file. He needs to know all the ramifications.

Jill in CO

 

[tvguy]

OP Here

I am strongly advising him NOT to do this. However, when you're left with no where to turn, and on the brink of losing your home & filing bankruptcy....I want him to be well informed of the consequences.

Like others have pointed out, he needs professional advice. But given the choice between cashing out an 401k or IRA.......or bankruptcy, I'd have to say bankruptcy is the best option.