Taxes on a Lump Sum Payment From a 401(k)

by Fraser Sherman, Demand Media Google

    Instead of letting a 401(k) provide a steady stream of retirement income, you can empty the account in one lump-sum withdrawal. Some plans do this automatically when you turn 70 1/2 or retire, but you can take the lump sum out earlier if you quit or get fired. The tax impact varies with circumstances.

    Lump Sum Taxes

    Your 401(k) withdrawals are taxable income, just like your salary. If you have $40,000 in the plan and take it out in a lump sum when you quit, your income for the year goes up $40,000. Unless you have a lot of deductions that year, this may be enough to shove you into a higher tax bracket. Withdrawals before you turn 59 1/2 are subject to a 10 percent tax penalty, unless you are 55 years old and leaving a job.

    Rollover

    You don't have to pay tax on the lump sum you took out if within 60 days you roll it over to a traditional IRA. Any longer than that, even by a day, and the Internal Revenue Service treats it as if you took out the money to keep. You can avoid that by just asking the 401(k) administrator to transfer your money to the IRA for you. If you choose to roll over part of your distribution and keep the rest, you pay tax on the part you keep.

    Hardship Withdrawal

    If you empty your account because of an emergency, you still have to pay income tax, but you may be off the hook for penalty taxes. The IRS allows employees to make hardship withdrawals -- which can be some or all of the 401(k)'s contents -- to pay for such things as tuition, high medical bills or buying a house. Your 401(k) plan doesn't have to allow this, though most do, and you may have to show the administrator you have no other way to get the money.

    Reporting

    You report your 401(k) withdrawals on the front of your 1040 form, on the space for "pension and annuity income." There's one box for total withdrawals, one for the taxable amount. If you rolled over your entire lump-sum withdrawal, you put down zero in the second box. The plan sends you a 1099-R identifying how much you withdrew and how much of it was taxable. Another copy goes to the IRS.

    About the Author

    A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.