How much tax is due on your 401(k) withdrawal depends on how and why you're taking the money out. Some transactions require 20 percent withholding, and others incur an additional 10 percent early-withdrawal penalty if you're under age 59 1/2, which you'll pay when you file your tax return.
If you leave your employer for any reason — a new job or getting laid off — you're entitled to take your 401(k) money out, no questions asked. If you take the money directly, a flat 20 percent is withheld for federal taxes, even if you roll it over within a 60-day limit. If you keep the cash longer than that, you're out of luck. The disbursement becomes regular income and, depending on your tax bracket, you'll probably owe more than the withholding. You'll also get slapped with a 10-percent early-withdrawal penalty.
If you're over 55 when you retire you can start taking money out of your 401(k) without the 10-percent penalty. You'll still have to pay the 20-percent withholding on each disbursement. You'll get a refund for any overpaid withholding when you file your tax return. Most retirees are in a lower tax bracket than when they were working, so your overall effective tax rate is likely to fall anyway.
Whether you leave your employer or retire, you can roll your 401(k) it into a Roth IRA or a retirement plan at your new company. If you handle your rollover correctly, you won't risk either the 20 percent withholding or the additional 10 percent early-withdrawal penalty for missing the 60-day window. Decide where you want the money to go and have the new account custodian handle the money as a direct transfer without it passing through your hands. That's faster, and you won't get an ugly surprise tax bill if the 60-day window closes while you're deciding how to invest.
If you can prove you have no other resources to cover college, medical, funereal, or emergency-related costs, your employer may allow you to take a hardship withdrawal. You'll have to pay 20 percent withholding from the disbursement check and a 10-percent penalty on the withdrawal when you file your tax return. Make sure to factor in the withholding when deciding how much to withdraw to cover your emergency.
Every 401(k) distribution, including a direct rollover gets you a Form 1099-R. The "R" is for "retirement." The 401(k) plan custodian will either mail it in late January or you can access it online at their website. It will show how much is taxable income and how much was withheld. If you're subject to an early-withdrawal penalty, there will be a 1 in Box 7. Include your taxable distribution as pension income on line 16b of Form 1040. File Form 5329 to calculate the 10-percent penalty.
Naomi Smith has been writing full-time since 2009, following a career in finance. Her fiction has been published by Loose Id and Dreamspinner Press, among others. She holds a Master of Science in financial economics from the London School of Economics and a Bachelor of Arts in political economy from the University of California, Berkeley.