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.
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.
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.
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.
- Internal Revenue Service: 401(k) Resource Guide - Plan Participants - General Distribution Rules
- AXA Equitable: Make the Most of Your 401(k)
- Internal Revenue Service: Retirement Plans FAQs Regarding Hardship Distributions
- Internal Revenue Service: Form 1040
- Bankrate.com: Reporting 401(k) and IRA Rollovers
- Things to Know About College Financing
- Can Taxes You Pay on Your House Be Deducted on Your Federal Return?
- Tax Deduction for a Loss in a 401(k) Plan
- Tax Deductions on Meal & Entertainment Expenses
- Is the Money I Paid for My Children's Health Insurance Tax-Deductible?
- Are Medical Expenses for Having a Baby Tax-Deductible?
- How to Set Up a Quarterly Estimated Tax Deduction From My Account
- Are Multiple Moves to a New Job Tax Deductible?
- Spousal Support As a Tax Deduction
- Tips for Income Tax Mileage Deductions