Business Development Officer, T.D. McNeil Insurance Services, Fresno, California
Company sponsored retirement program can have provisions that allow participants to withdraw funds from their active program. The criteria for who can exercise these options are detailed in the plan documents which are normally available from the company headquarters. Some plans allow withdrawals to assist in the purchase of a home, to pay for education, or emergencies. The withdrawal provision will often require that the amount withdrawn be repaid and might stipulate a specific time frame for the repayment.
The Internal Revenue Service looks at these withdrawals as distributions and taxes them accordingly. If the retirement fund is entirely money contributed by the employer, the distribution would be treated as ordinary income and if the employee is less than 59.5 years old an additional 10% penalty tax is also applied.
The same general taxation is applied if the employee contributes to the pension plan but the contribution has not been taxed as income. This is a salary reduction agreement. This is the most common form of pension plan today. If the employee has made “after-tax” contributions to the pension plan those are treated differently and some or part of the withdrawal might be seen as a return of principle.
The determination of tax is done by the employer’s accounting firm. They will notify the employee if any tax is due. The employee must report this to the IRS which will determine if the penalty tax applies.
There are exceptions to the early distributions penalty tax. If the qualified plan had an auto-enrollment feature and the employee decides to not participate in the plan, that withdrawal is an exception to the early withdrawal tax.
If the amount placed in the plan exceeds the annual allowance under the Internal Revenue Code, money can be withdrawn without penalty to bring the plan into conformity. These withdrawals must be made in a timely manner. When the participant dies, or becomes totally and permanently disabled, the money from the retirement fund can be distributed without incurring the early withdrawal tax.
If the money is being withdrawn from the retirement fund to satisfy a qualified domestic relation order the distribution will not be subject to the early withdrawal tax. This occurs frequently in divorce proceedings. If the employee withdraws substantially equal payments over a period of time those distributions would not be subject to the early withdrawal tax. This can be quite tricky and legal and accounting advice should be sought. There isn’t an early withdrawal tax on the amount withdrawn if the Internal Revenue Service has put a levy on the pension plan.
If money is withdrawn to pay medical expenses that exceed 10% of the Annual Adjusted Gross income of the employee, those distributions are not subject to the early withdrawal tax. If withdrawals from a pension plan are being done by a qualified military reservist who has been activated, those distributions will be exempt from the early withdrawal tax If the withdrawal is from the current plan to another, particularly if it is being done from one trustee to another there will not be an early withdrawal tax. If the employ has reached age 55 and is separating from service with the company, the distribution will not trigger the early withdrawal tax.
To determine how this tax will affect you contact your plan administrator, accountant or attorney.
Insurance Adviser - Broker, SC Insurance Services, Oahu, Hawaii
Looks like David has covered the question pretty thoroughly so I'll just give the short answer. When you withdraw from your 401K early - that is before reaching age 55, you will be taxed on the entire amount. Then you will be penalized ten percent of the pre taxed amount. On top of that you may also have a percentage withheld for income tax for the year of withdrawal.
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The Internal Revenue Service looks at these withdrawals as distributions and taxes them accordingly. If the retirement fund is entirely money contributed by the employer, the distribution would be treated as ordinary income and if the employee is less than 59.5 years old an additional 10% penalty tax is also applied.
The same general taxation is applied if the employee contributes to the pension plan but the contribution has not been taxed as income. This is a salary reduction agreement. This is the most common form of pension plan today. If the employee has made “after-tax” contributions to the pension plan those are treated differently and some or part of the withdrawal might be seen as a return of principle.
The determination of tax is done by the employer’s accounting firm. They will notify the employee if any tax is due. The employee must report this to the IRS which will determine if the penalty tax applies.
There are exceptions to the early distributions penalty tax. If the qualified plan had an auto-enrollment feature and the employee decides to not participate in the plan, that withdrawal is an exception to the early withdrawal tax.
If the amount placed in the plan exceeds the annual allowance under the Internal Revenue Code, money can be withdrawn without penalty to bring the plan into conformity. These withdrawals must be made in a timely manner. When the participant dies, or becomes totally and permanently disabled, the money from the retirement fund can be distributed without incurring the early withdrawal tax.
If the money is being withdrawn from the retirement fund to satisfy a qualified domestic relation order the distribution will not be subject to the early withdrawal tax. This occurs frequently in divorce proceedings. If the employee withdraws substantially equal payments over a period of time those distributions would not be subject to the early withdrawal tax. This can be quite tricky and legal and accounting advice should be sought. There isn’t an early withdrawal tax on the amount withdrawn if the Internal Revenue Service has put a levy on the pension plan.
If money is withdrawn to pay medical expenses that exceed 10% of the Annual Adjusted Gross income of the employee, those distributions are not subject to the early withdrawal tax. If withdrawals from a pension plan are being done by a qualified military reservist who has been activated, those distributions will be exempt from the early withdrawal tax If the withdrawal is from the current plan to another, particularly if it is being done from one trustee to another there will not be an early withdrawal tax. If the employ has reached age 55 and is separating from service with the company, the distribution will not trigger the early withdrawal tax.
To determine how this tax will affect you contact your plan administrator, accountant or attorney.