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How much tax on 401k distribution (not early just regular)
One of my friend who is 65 years old was told by some financial adviser that he has to pay mandatory 40% tax on 401k distributions.
is that true? I thought the taxes on the 401k or IRA will depend on the tax bracket for that year. He is living off disability income. He is not working anymore due to illhealth.
My 403b withdrawal of about $18K/year is subject to a 20% tax withholding. In my case it just lowers my quarterly tax payments.
However, everything has a million views. It might be beneficial to download TaxAct (or another) free version and look at the impact of the 401K distribution. If the friend is collecting Social Security (SS), the taxes owed on the SS, itself, might increase if the friend goes from one cutoff to another determining the % of SS subject to taxation. If this were occurring and the friend needed a certain amount over his current after tax income then he would need to withhold both the tax on the 401k withdrawal and the increase in tax owed on the Social Security. This can appear to be a real ouch, in some cases, in terms of additional money needed from the 401k account.
Ahh ... It should be taxed as ordinary income. The % will fluctuate with your (graduated) tax bracket - which will, of course, be higher if the 401-K distribution pushes your gross income up significantly. In addition, some fiduciaries (read: fund companies) impose an automatic withholding rate on distributions to CTA and comply with applicable tax law. Most also allow you to specify a different percentage (15% for example) or opt-out completely - but some may not. This withholding is automatic unless you elect to opt-out or change the amount. The 40% mentioned sounds extraordinarily high as a fiduciary-imposed automatic withholding rate. 20-25% at the Federal level is much more common. There may well be some special circumstances affecting your friend's situation that haven't been shared.
In Michigan the state has really put the onus on the fiduciary to do mandatory withholding and the state's requirements appear more rigid than what the Federal government requires. Opting-out requires obtaining a special form from the state and than submitting the request in writing to the fiduciary. Be careful with any opt-out or other withholding rate decisions, as there are substantial and serious penalties should you fail to pay the legally required minimum tax at the time of distribution.
Reply to @bnath001: From God's lip's to your friend's ear, if the financial advisor, which I doubt, said the tax was a mandatory 40%, he should immediately be fired. Hank is correct, the distribution is taxed as ordinary income. Regards, Ted
Hank noted: "In Michigan the state has really put the onus on the fiduciary to do mandatory withholding and the state's requirements appear more rigid than what the Federal government requires." Not unlike many tax rules in place; there are any number of "however" and related modifying words for various circumstances. One such provision for Michigan is what Hank noted about mandatory withholding at "x" percentage rate that applies to each monthly pension or retirement monies one receives. 'Course, this is a sweet deal for the state, as the tax monies arrive upfront and every month. Any "overpay" of taxes becomes a possible refund to the taxpayer some 14 months later. However, one twist for the mandatory tax withholding that is in place; is the pension or retirement distribution comes from a payer that also resides in the state of Michigan.
If one receives their pension/retirement distribution from an out of state payer, the mandatory portion of taxation may be waived by the retiree. Whatever tax is due, is payable when filing the previous year tax forms. A penalty for underpayment can take place. But, this would have to be calculated against and include all other household income to determine whether underpayment of taxes will happen.
Comments
http://taxes.about.com/od/Withholding/a/Withholding-On-Retirement-Plan-Distributions.htm
Old_Skeet
However, everything has a million views. It might be beneficial to download TaxAct (or another) free version and look at the impact of the 401K distribution. If the friend is collecting Social Security (SS), the taxes owed on the SS, itself, might increase if the friend goes from one cutoff to another determining the % of SS subject to taxation. If this were occurring and the friend needed a certain amount over his current after tax income then he would need to withhold both the tax on the 401k withdrawal and the increase in tax owed on the Social Security. This can appear to be a real ouch, in some cases, in terms of additional money needed from the 401k account.
Monthly distribution.
Old_Skeet, I will go thru the link you provided. But can it reach 40% taxes on 401k drawals? Hard to believe.
In Michigan the state has really put the onus on the fiduciary to do mandatory withholding and the state's requirements appear more rigid than what the Federal government requires. Opting-out requires obtaining a special form from the state and than submitting the request in writing to the fiduciary. Be careful with any opt-out or other withholding rate decisions, as there are substantial and serious penalties should you fail to pay the legally required minimum tax at the time of distribution.
Regards,
Ted
Not unlike many tax rules in place; there are any number of "however" and related modifying words for various circumstances.
One such provision for Michigan is what Hank noted about mandatory withholding at "x" percentage rate that applies to each monthly pension or retirement monies one receives. 'Course, this is a sweet deal for the state, as the tax monies arrive upfront and every month. Any "overpay" of taxes becomes a possible refund to the taxpayer some 14 months later.
However, one twist for the mandatory tax withholding that is in place; is the pension or retirement distribution comes from a payer that also resides in the state of Michigan.
If one receives their pension/retirement distribution from an out of state payer, the mandatory portion of taxation may be waived by the retiree. Whatever tax is due, is payable when filing the previous year tax forms. A penalty for underpayment can take place. But, this would have to be calculated against and include all other household income to determine whether underpayment of taxes will happen.
nath