How to Calculate Tax to Withhold on a 401(k) Distribution

You could find yourself with a stiff tax bill if you underwithhold from your 401(k) distribution.

You could find yourself with a stiff tax bill if you underwithhold from your 401(k) distribution.

Most people never plan to tap their 401(k) plans before retirement, but sometimes financial circumstances leave you with no other options. When you do take an early distribution, selecting the proper amount to have withheld from your 401(k) distribution helps you avoid a nasty surprise when you file your taxes.

Withholding Basics

When you fill out your 401(k) distribution request form, you have the option to select how much you want withheld for income taxes. The default withholding is 20 percent -- which is the minimum your employer will take out for taxes. For example, if you request a distribution of $1,000, even if you don't select a higher withholding amount, you're only going to receive an $800 check. If you have too much withheld, you'll get a refund when you file your taxes. If you have too little taken out, you'll owe the extra at tax time.

Federal Income Taxes

The first step to figuring how much you should have withheld from your 401(k) distribution is to estimate your marginal tax rate for federal taxes. The tax brackets depend on your filing status and how much other income you have. For example, in 2013 if you're single, the first $8,925 is taxed at 10 percent and income between $8,925 and $36,250 is taxed at 15 percent. If you have $10,000 of other income and take a $5,000 401(k) withdrawal, that $5,000 is taxed at 15 percent.

Early Withdrawal Penalty

When you cash out your 401(k) before you turn 59 1/2, the IRS tacks on another 10 percent as a penalty unless you qualify for an exception. Exceptions are limited and include an amount equal to your medical expenses in excess of 10 percent of your adjusted gross income, a permanent disability or a qualified domestic relations order. If you don't qualify for an exception, that's another 10 percent that should be withheld to cover your tax bill. So, if you expect to owe 15 percent in income taxes, adding the 10 percent penalty means you need to have 25 percent withheld in total.

State Income Taxes

If your state charges an income tax, consider requesting withholding for your state taxes, too. This is a separate item on your 401(k) distribution form. Some states have mandatory withholding, while others leave the decision up to you. You can estimate the proper percentage to withhold based on your state income tax brackets the same way you figured the federal withholding.


About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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