taxes

Taxes owed on an early 401(k) distribution

Judy O'ConnorDear Tax Talk,
If I cash out my 401(k) totally -- worth $44,170 -- at what percentage will I be taxed and how much will I receive after taxes?
-- Kathy

Dear Kathy,
The amount of taxes owed on your 401(k) distribution will depend on what tax bracket you are in when the income is added to your taxable income. Additionally, you may be subject to a 10 percent penalty if you are under age 59 1/2.

Cost of an early 401(k) distribution | coins: ©Bplanet/Shutterstock.com, piggy & moths: © Mike Elliott/Shutterstock.com

Your 401(k) plan is what is known as a qualified deferred compensation plan where you as an employee can elect to have your employer contribute a portion of your salary on a pretax basis to the plan. They are a wonderful retirement incentive as your contributions are growing on a tax-deferred basis, and additionally some employers also contribute matching funds up to certain limits. Hopefully you are making your contributions when your income is in a higher tax bracket and you'll be paying a lower tax rate when you are retired.

The general rule is that you include the distributions in your income in the year received. If you were born before Jan. 2, 1936, and you receive a lump-sum distribution, you may be able to elect optional methods of figuring the tax on the 401(k) distribution.

The government really wants you to keep that money working for you until you are retired, and there may be a 10 percent penalty for early distributions -- which means those made before you reach the age of 59 1/2. There are several exceptions regarding the 10 percent additional tax on early 401(k) distributions. They include the following:

  • Distributions are due to total and permanent disability or your death.
  • They were made under the rules for "substantially equal periodic payments" after you have left your job.
  • If you were 55 years or older when you left your job, distributions made after you left will qualify. However, the age limit is 50 years or older if you were a "qualified public safety employee," which means you provided police protection, firefighting services or emergency medical services for a state or municipality.
  • Distributions were made to the extent you have deductible medical expenses that exceed 10 percent of your adjusted gross income (7.5 percent if you or your spouse was born before Jan. 2, 1949).
  • Distributions were received under a specified written agreement and you had left your job as of March 1, 1986.
  • Distributions were due to an IRS levy.
  • Certain "qualified reservist" distributions may also be penalty-free.

Since you do not provide enough of your specific information to me, I am unable to calculate how much you will receive after taxes. However, I hope this information helps you figure it out on your own.

Thanks for the great question and all the best to you.

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