What are the exact and full 401K penalties for full withdrawal?

Question

Help settle a debate now with a friend. She (age 29) has right at 100K in her 401K, and for reasons that don’t matter to the debate were guessing if she cashed out her entire 401K, it would leave her with about 70K. The basis for this is her understanding of how the full withdrawal works. She reads her company would keep 20% for federal tax, and you have the 10% early withdrawal.

I am telling her it would be more than that amount. I estimate her salary would put her above a 20% federal taxes hit, and was thinking it was more like 24%, and the state of IL would hit her for an additional 8% in taxes. I estimated she would be looking more at 58K after all was said and done with.

I also understand her company locks her out of the 401K plan for a full year. It is obviously a big mistake to totally drain her 401, but who is closer to the correct ‘end’ amount, after ALL taxes and penalties?

Answer 1

You are far closer to correct. Actually, it's probably a bit worse than you stated and worse than the above poster stated.

The withdrawal is fully taxable at her marginal rate. On top of that, there is a 10% penalty tax since she's under age 59 1/2. Her marginal rate is determined by her taxable income PLUS the 401(k) distribution. Here's a link to the tax rate table for 2007. http://www.irs.gov/formspubs/article/0,,id=164272,00.html

In most cases a $100k withdrawal would span 2 or 3 tax rates but most of it would probalby fall in the 28% bracket. Using that for argument's sake as it's close, the total tax will be $38,000 on the early distro -- 28% tax rate + 10% penalty tax.

The distribution will be subject to withholding at 20% but the total tax liability will be determined as stated above. She'd probably have a tax bill at tax time of $18,000 or so since not enough will be withheld when she receives the distribution. She'd also have the state tax to contend with. If her state marginal rate is 8%, that's another $8,000 down the pooper, leaving her with a total tax bill of about $46,000 and only $54,000 of her $100,000 left for her.

If she's still employed, the company is under NO obligation to allow the distribution at all. She would have to quit her job to make the withdrawal under the rules of every 401(k) that I've ever dealt with.

A far more intelligent option if she needs some quick cash would be to take a loan from her 401(k). Those are done at attractive interest rates (7% it typical) and the interest paid goes back into the account so it really costs you nothing at all. The only catch is that if she leaves the job, the entire loan must be paid in full or it will be treated as an early distribution at her age and taxed as above.

As you can see, taking an early withdrawal form a tax-deferred retirement plan is never a good idea financially today and will have disasterous consequences at retirement time. That $100k in the account today will probalby double 5 or more times if no further contributions are made. It could be worth well over $2,500,000 at retirement time even using very conservative rates of return. If she takes it out today, of course it would be worth $0 at retirement.

Answer 2

This Site Might Help You.

RE:
What are the exact and full 401K penalties for full withdrawal?
Help settle a debate now with a friend. She (age 29) has right at 100K in her 401K, and for reasons that don’t matter to the debate were guessing if she cashed out her entire 401K, it would leave her with about 70K. The basis for this is her understanding of how the full withdrawal works. She...

Answer 3

Penalty For 401k

Answer 4

Upfront she will lose the 30%, it isn't until tax time that the other shoe will drop. If she is still employed with the employer she could take a a loan from the 401k and avoid the hit.

Answer 5

You are correct - technically. Yes, she would get $70K if she cashed out - BUT when she prepares her 2007 personal tax return, any remaining taxes that she owes on that amount will be figured - like you said - based on her salary/income bracket etc. So she may very well end up owing additional monies to the IRS if her refund isn't large enough to offset it. She would be wise to set aside an extra $10k to 15k of the $70k just in case.

Answer 6

You are closer to correct.

The 20% is the withholding. The actually tax bill (and penalty) will be much higher than that.

Do not drain the 401k!