YIKES...20% Fed Tax on 401K Distribution

[Jackietime]

I will soon be retired (forced surplus) from Megacorp after 33 years of service.

Firecalc and plenty other calculators and three different FPs say I will have 99+% success rate based on my assets and spending plan BUT... what the plans do not show is the 20% fed income tax that will be withheld from my 401K distributions. I just confirmed this today!!! The only way to avoid it is to roll over to an IRA... but I am 58, not 59 1/2 so I was depending on a partial distribution from my 401K plan (which the plan does allow since I'm over 55) to tide me over until the rollover, but I did not realize the Fed would take 20% off the top! Holy Moly!

Oh well.. guess there's no way around it, but it will increase my WR over the 4% SWR.

Anyone else in retirement face this issue and if so, can you share the consequences? Any thoughts, suggestions from anyone??

 

[pb4uski]

I haven't faced this issue, but the saving grace is that the 20% is just withholding and to the extent your tax is lower, which is likely, you'll get a refund and can reduce your distributions in 2016. I suspect there is a way around it but no firsthand knowledge.

 

[Texas Proud]

That is withholding, not the tax you will have to pay...

Unless there is something else that will increase your taxes, you will get it back when you file your return...

 

[MRG]

Right, just withholding you get excess back. I was pleasantly surprised by last year's taxes. In your planning, did you account for the tax liability on tax deferred distributions?

 

[daylatedollarshort]

The only offset we know of is we take 401K distributions early in the year and then not make any quarterly tax payments for our other income streams. We set the pension income tax withholding to zero as we take those as annuities. The 20% withholding on the 401K distributions covers all the tax we owe for the year and then some.

 

[Lakewood90712]

Take a deep breath and relax.

Plenty of work around's to avoid most of the 10% early withdrawal penalty. Do all of the 401 to IRA as direct roll overs. No withholding on direct roll overs. Do multiple accts. If your plan allows, partial withdrawals, several over multiple years may help The 72t provision may help. Don't know if the tax code has any hardship provisions on the 10% early w/d penalty.Get some pro. tax advise.

Surplussed ? haven't herd that one in a while.

 

[marko]

Don't most 401K/IRA administrators give you the choice of 10%, 15%, 20% or 25% withheld? As noted, done right you'll get a refund at year's end.

 

[pb4uski]

Take a deep breath and relax.

Plenty of work around's to avoid most of the 10% early withdrawal penalty. Do all of the 401 to IRA as direct roll overs. No withholding on direct roll overs. Do multiple accts. If your plan allows, partial withdrawals, several over multiple years may help The 72t provision may help. Don't know if the tax code has any hardship provisions on the 10% early w/d penalty.Get some pro. tax advise.

Surplussed ? haven't herd that one in a while.

OP is referring to the 20% mandatory federal withholding tax, not the 10% early withdrawal penalty.

 

[Lakewood90712]

OP is referring to the 20% mandatory federal withholding tax, not the 10% early withdrawal penalty.

Maybe it's just me, but I would be a whole lot more concerned with minimizing/avoiding a 10% penalty , than withholding for tax that is either owed, or returned as a refund. The op has 1 or 2 tax years before 59 1/2 . Paying a penalty on money used to live on when laid off sucks. period.

 

[hnzw_rui]

I haven't faced this issue, but the saving grace is that the 20% is just withholding and to the extent your tax is lower, which is likely, you'll get a refund and can reduce your distributions in 2016. I suspect there is a way around it but no firsthand knowledge.

Yup, exactly. Alternately, you can use cash in taxable accounts and just replenish it with your tax refund. Workaround is rollover IRA + 72t but I don't think doing 72t is worth the hassle for just 1 year of distributions.

 

[MRG]

Maybe it's just me, but I would be a whole lot more concerned with minimizing/avoiding a 10% penalty , than withholding for tax that is either owed, or returned as a refund.

Some 401k's allow for penalty free withdrawals for terminated from service after age 55. No need for 72t. Sounds like OP has one of those.

 

[Jackietime]

Right, just withholding you get excess back. I was pleasantly surprised by last year's taxes. In your planning, did you account for the tax liability on tax deferred distributions?

Yes.. I did.. much less than current tax rate.. so that is a good thing..

 

[Jackietime]

Take a deep breath and relax.

Plenty of work around's to avoid most of the 10% early withdrawal penalty. Do all of the 401 to IRA as direct roll overs. No withholding on direct roll overs. Do multiple accts. If your plan allows, partial withdrawals, several over multiple years may help The 72t provision may help. Don't know if the tax code has any hardship provisions on the 10% early w/d penalty.Get some pro. tax advise.

Surplussed ? haven't herd that one in a while.

I will avoid the 10% early withdrawal penalty because I am over 55..

Yep.. surplus is what they called it here at Megacorp.. i.e... they are reducing headcount and beefing up the profits by getting rid of some of us.

 

[Jackietime]

Don't most 401K/IRA administrators give you the choice of 10%, 15%, 20% or 25% withheld? As noted, done right you'll get a refund at year's end.

No choice here.. it's 20% .. but like you and others have said, we should get a decent refund after allowing the govt to use our money all year interest free! I guess I'm a little pee'd.

 

[Jackietime]

Maybe it's just me, but I would be a whole lot more concerned with minimizing/avoiding a 10% penalty , than withholding for tax that is either owed, or returned as a refund. The op has 1 or 2 tax years before 59 1/2 . Paying a penalty on money used to live on when laid off sucks. period.

I would want to keep working until 59 1/2 if I had to face a 10% penalty. Fortunately the plan allows the rule of 55.

 

[Jackietime]

Thanks to you brilliant folks, I feel less panicked!!

Cashing in a portion of our taxable accounts first and taking a distribution later in the year from the pre-tax sounds like a plan I need to explore. And then I could reduce the distribution the following year based on the refund amount or replenish the taxable account.
Thanks again, ER members!!

 

[Fermion]

No choice here.. it's 20% .. but like you and others have said, we should get a decent refund after allowing the govt to use our money all year interest free! I guess I'm a little pee'd.

Well, 1% is about the best you could do with that money, so if we are talking about $50,000, then the government is only getting $500 from you.

 

[audreyh1]

Not only that, but if you are getting income from other sources, you don't have to pay estimated taxes on that if the withholding covers it.

 

[MRG]

Yes.. I did.. much less than current tax rate.. so that is a good thing..

You're good, relax and enjoy life!

 

[GravitySucks]

Same boat. Retired at 54 under the rule of 55 and avoided the 10% penalty. I left enough in the 401k to last until I'm 60 and rolled the remainder into an IRA.
That manditory 20% withholding was a shock but after year one it leveled out with a nice tax return. Uncle Sam can keep the interest at these rates.

Sent from my Nexus 7 using Early Retirement Forum mobile app

 

[thefinancebuff]

Firecalc and plenty other calculators and three different FPs say I will have 99+% success rate based on my assets and spending plan

The spending number has to include taxes. If you didn't count taxes as spending, better re-run those calculators.

 

[pb4uski]

The spending number has to include taxes. If you didn't count taxes as spending, better re-run those calculators.

It looks like the OP did include taxes in their planning.

.....In your planning, did you account for the tax liability on tax deferred distributions?

Yes.. I did.. much less than current tax rate.. so that is a good thing..

 

[Jackietime]

Thanks Gravitysucks . It's nice to know someone else was surprised about it.