Tax Question

[Knoxville]

Say a person had to cash out a 401K fund due to some unfortunate financial expenses. The 401K was in Bank of America retirement plan. If there was $2600 in the 401K a check was cut to that person for around $2150. Now that person will get sent a 1099?? by that employer.. How much additional taxes will have to be paid on the 2600$? Another 10%? 20%? Is that of the original amount? The check that they send, is the penalty not included in that?

Knox

[blm]

When I cashed my 401k out back in 2000 I ended up paying 30% in taxes.

[Knoxville]

Is that an additional 30% after you got your check cut? They held some federal tax on mine from the original amount?

[blm]

No. They took 10% initially and 20% in the end.

[babyblues]

They impose a 10% penalty for early withdrawal. Since 401k deductions are pre-tax in the year they were deducted(they reduced the taxable income from your original paycheck and you didn't pay taxes on that income) they along with any earnings are taxed as ordinary income in the year you take the money out. It depends on what tax bracket you're in as to what rate that income is taxed at.

[bonebreaker]

Say a person had to cash out a 401K fund due to some unfortunate financial expenses. The 401K was in Bank of America retirement plan. If there was $2600 in the 401K a check was cut to that person for around $2150. Now that person will get sent a 1099?? by that employer.. How much additional taxes will have to be paid on the 2600$? Another 10%? 20%? Is that of the original amount? The check that they send, is the penalty not included in that?

Knox

They have already taken a 10% penalty, plus have withheld federal and state taxes, (if you live in a state that has income tax). When you file at year end, the entire amount of the cashed out 401k, ($2600.00) will have to be added to your return as additional income for the year it was withdrawn. So basically, you treat it as income just the same as if you had two jobs. The amounts withheld are used just as any other deduction from your total tax bill for the year. So, based on your total TAXABLE income, if you have big deductions, (say mortgage interest on your home), you may not have to pay any further taxes. However, if you made a bunch of money and didn't have your employer withhold enough each week, you may indeed be hit with another payment to the government when you finish your return. BB

[Knoxville]

I am a single guy, so I always keep my dependents set at 0, and 0. I kind of use my fed and state taxes as a savings plan. Last year I ended up getting around 2300$ back after I filed my W2. I don't have any deductions that I can file. I rent my house since I have only been at my current job about 9 months. I have other incomes, but I'll be darned if I disclose that to anyone, due to not being legal kind of sales. Noo it does not have anything to do with AAS. Thanks for the insight, I'm retarded when it comes to do with taxes. I guess that's what the tax lady back home is for. Thanks for the input.

Knox

[SonofBone]

Knox...you need to check because I don't believe any penalty has been taken. 10% of 2600 doesn't equal 2100. I'm guessing your employer has a vesting schedule. Most employers have a 5 or 7 year plan. Say you've been there for 4 years then you're probably 80% vested and you got 80% of the 2600. This would mean that you're only liable on the amount that the check was sent to you for. It would be a 10% penalty on that amount & then you're normal income tax rate on that amount again, so you could pay about 38% on that 2100. Best bet would be to check with your payroll, tax or retirement department for clarification & possibly seek professional tax advice.

[Knoxville]

any which a way I look at it, I'm going to have to pay. Sitting around worrying about it isn't going to do me any good. I just need to wait til I get my W2's and the form from retirement company (BOA) and take it all to the tax lady and see what she can do. I never file my own taxes, too much room for error on my part. I'll post later on how much it actually costs me once it's all said and done. Thanks SOB... no pun intended.

Knox

[bonebreaker]

Knox...you need to check because I don't believe any penalty has been taken. 10% of 2600 doesn't equal 2100. I'm guessing your employer has a vesting schedule. Most employers have a 5 or 7 year plan. Say you've been there for 4 years then you're probably 80% vested and you got 80% of the 2600. This would mean that you're only liable on the amount that the check was sent to you for. It would be a 10% penalty on that amount & then you're normal income tax rate on that amount again, so you could pay about 38% on that 2100. Best bet would be to check with your payroll, tax or retirement department for clarification & possibly seek professional tax advice.

It doesn't matter if the amount was 80% or 8%. $2600.00 was the amount he said he had in the account. His employer is required BY LAW, to withhold a 10% penalty plus federal AND state taxes on the amount withdrawn. Of course, that being said, if they f'd up, he will still be liable. It does appear, however, that the $450.00 withheld is less than half what it should have been, (considering he probably IS in the 28% tax bracket, then tack on 10% penalty). IF that's what happened, he will have an additional $538.00 tax burden. But, he has gone 0-0 withholding, (state & fed), so he may not get popped too badly. He just won't have his year end bonus as usual.

And, I don't think most employers contribute to employee's 401k, conversly so, only the very good companies. So, he is immediately vested 100% if all the contributions are his and his alone. BB

[SonofBone]

It doesn't matter if the amount was 80% or 8%. $2600.00 was the amount he said he had in the account. His employer is required BY LAW, to withhold a 10% penalty plus federal AND state taxes on the amount withdrawn. Of course, that being said, if they f'd up, he will still be liable. It does appear, however, that the $450.00 withheld is less than half what it should have been, (considering he probably IS in the 28% tax bracket, then tack on 10% penalty). IF that's what happened, he will have an additional $538.00 tax burden. But, he has gone 0-0 withholding, (state & fed), so he may not get popped too badly. He just won't have his year end bonus as usual.

And, I don't think most employers contribute to employee's 401k, conversly so, only the very good companies. So, he is immediately vested 100% if all the contributions are his and his alone. BB

You really don't have all the information needed to answer everything. He didn't say if he invested the money or his company did, if they have a vesting schedule, or if he can borrow against the account.

A lot of plans will allow you to borrow up to 50%, but the amount is the discretion of the employer. That could mean they allow up to 80%. If that is the case, they may have treated it as a loan. In that case, they're not taking out any penalties, and it would be his responsibility to repay the loan plus interest in a reasonable time frame. If it wasn't repaid in a reasonable time frame then he would have to pay out of pocket for the income taxes & penalty.

Like I said, he didn't give all the facts. He just said he had 2600 and got a check for 2100, so you might have a lucky guess, but you don't have the definitive answer based on the facts he provided, period.

[babyblues]

You really don't have all the information needed to answer everything. He didn't say if he invested the money or his company did, if they have a vesting schedule, or if he can borrow against the account.

Hmmm...well, actually he's right. And there's all the information you need to give the correct answer. 1st: Knoxville stated that "this person" had $2,600 in a 401k and that it was in a Bank of America retirement plan. Sounds like it was a bonafide 401k to me. 2nd: As far as vesting goes, that only applies to a company match. A company may require that an employee work for 6 months before they are eligible for a company contribution to their 401k. The company is required by federal law to remitt withholdings to the 401k plan administrators and they are required by federal law to properly invest that money as stipulated in the 401k plan. A plan actually has to meet some specific criteria in order to be considered a 401k plan and afford the employee the pre-tax treatment of those deductions thus deferring the taxes on that income until withdrawal.

They may have qualified for a "Hardship" early withdrawal. If that's the case, the withdrawal is still subject to the 10% early withdrawal penalty and state withholdings but not federal withholdings.

Since the check was for around $2,150 it seems that the penalty of 10%, social security taxes of 6.2% and medicare of 1.45% were withheld. The math works out to $260.00 in penalties, $161.20 in social security taxes and $37.70 in medicare taxes. I don't know why state or federal taxes were not withheld, but it's still going to be taxable income. "This person" will have to wait until they receive the 1099. It will show what was withheld.

A lot of plans will allow you to borrow up to 50%, but the amount is the discretion of the employer. That could mean they allow up to 80%. If that is the case, they may have treated it as a loan. In that case, they're not taking out any penalties, and it would be his responsibility to repay the loan plus interest in a reasonable time frame. If it wasn't repaid in a reasonable time frame then he would have to pay out of pocket for the income taxes & penalty.

A loan on a 401k account is different than an early withdrawal. It's either classified as a loan or as an early withdrawal. It's not considered a loan at first and then an early withdrawal if he can't pay it back. Knoxville stated that "this person" cashed out the 401k account because of unforseen financial circumstances. That's early withdrawal, not a loan. And early withdrawal cannot be paid back. A loan is exactly that....a loan with your 401k as collateral. And that's usually done through a bank. If you default on that loan, it's between you and the lender.

Like I said, he didn't give all the facts. He just said he had 2600 and got a check for 2100, so you might have a lucky guess, but you don't have the definitive answer based on the facts he provided, period.

All you have to do is look at what the IRS has to say about it. In this case the facts are pretty cut and dried.

[SonofBone]

Babyblues...that is not the case. You can borrow directly from a 401K plan if your administrator runs it that way. The 401K is not used as collateral. Not saying that is or isn't what happened in this case.

I was merely trying to point out possible scenarios to Knox. Maybe there was a miscommunication between him and his employer.

Also, I know nothing about his situation, but the most preferable method would actually be to take a home equity loan because the interest is deductible whereas you have to pay back interest on a 401K loan. This means that you'll pay taxes on that interest down the road plus income tax on the money that you're having to repay. Anyway, just another thought.

See the link below regarding the collateral issue.

401K Plan Loans

If a participant has had no other plan loan in the 12 month period ending on the day before you apply for a loan, they are usually allowed to borrow up to 50% of their vested account balance to a maximum of $50,000. If the participant had another plan loan in the last 12 month period, they will be limited to 50% of their vested account balance, or $50,000, minus the outstanding loan balance in the preceding 12-month period, whichever is less.

Because of the cost, many plans will also set a minimum amount (often $1,000) and restrict the number of loans any participant may have outstanding at any one time.

Loan payments are generally be deducted from payroll checks and, if the participant is married, they may need their spouse to consent to the loan.

While interest rates vary by plan, the rate most often used is what is termed the "prime rate" plus one percent. The current "prime rate" can be found in the business section of your local newspaper or the Wall Street Journal.

Funds obtains from a loan are not subject to income tax or the 10% early withdrawal penalty (unless the loan defaults). If the participant should terminate employment, often any unpaid loan will be distributed to them as income. The amount will then be subject to income tax and may also be subject to 10% withdrawal penalty. A loan can't be rolled over to an IRA.

Not trying to be a SOB...just trying to clarify.

[babyblues]

Babyblues...that is not the case. You can borrow directly from a 401K plan if your administrator runs it that way. The 401K is not used as collateral. Not saying that is or isn't what happened in this case.

I was merely trying to point out possible scenarios to Knox. Maybe there was a miscommunication between him and his employer.

Also, I know nothing about his situation, but the most preferable method would actually be to take a home equity loan because the interest is deductible whereas you have to pay back interest on a 401K loan. This means that you'll pay taxes on that interest down the road plus income tax on the money that you're having to repay. Anyway, just another thought.

See the link below regarding the collateral issue.

401K Plan Loans

If a participant has had no other plan loan in the 12 month period ending on the day before you apply for a loan, they are usually allowed to borrow up to 50% of their vested account balance to a maximum of $50,000. If the participant had another plan loan in the last 12 month period, they will be limited to 50% of their vested account balance, or $50,000, minus the outstanding loan balance in the preceding 12-month period, whichever is less.

Because of the cost, many plans will also set a minimum amount (often $1,000) and restrict the number of loans any participant may have outstanding at any one time.

Loan payments are generally be deducted from payroll checks and, if the participant is married, they may need their spouse to consent to the loan.

While interest rates vary by plan, the rate most often used is what is termed the "prime rate" plus one percent. The current "prime rate" can be found in the business section of your local newspaper or the Wall Street Journal.

Funds obtains from a loan are not subject to income tax or the 10% early withdrawal penalty (unless the loan defaults). If the participant should terminate employment, often any unpaid loan will be distributed to them as income. The amount will then be subject to income tax and may also be subject to 10% withdrawal penalty. A loan can't be rolled over to an IRA.

Not trying to be a SOB...just trying to clarify.

Ah, that makes more sense. I would never ever ever ever ever touch the money in my 401k. There's precious little in it anyway. :D Home equity loans can be tricky too because they're limited to the home's fair market value in excess of any outstanding home acquisition debt, up to a maximum of $100,000. There's no way any bank is going to lend more than the equity you have in the property. But how you spend the money is irrelevant. Buy a car, pay for a vacation, pay off some credit card debt, etc... And the interest is still deductible.