401(k) Penalties?

Question

I have 25K in a 401(k) and would like to withdraw all of the funds for a better investment. My ex-employer matched my deposits.

a. What are the penalties associated with the withdrawal?
b. I know I must pay income tax on the amount, does that happen in the next tax year, or immediately?
c. Will my employer take back any matched funds, or are they mine?
d. Are there any breaks associated with paying off tuition costs?

Please spare me the lecture on taking out 401(k) funds, I have weighed my options carefully, and this would be the best decision for me.

Answer 1

a. Income tax plus 10% of the amount of the distribution

b. You will pay the tax in the year of the distribution. If withholding has not been taken from the distribution, you will pay the tax when you file your return in 2008 for 2007. Because this distribution will result in tax owed of more than $1,000, be sure to have at least 20% withheld from your distribution, or you may owe additional penalties for underpayment of tax.

c. As long as your contribution is "vested" your employer match is yours and can be withdrawn. Check with the plan administrator to make sure you have access to the employer match.

d. Are you planning on paying off old student loans, or are you planning on paying tuition for school attended in 2007? If you are paying off student loans, there are no tax breaks. If you are paying tuition, you can rollover the tuition amount into an IRA, withdraw it from the IRA, and pay no early withdrawal penalty. You may also be eligible for the Tuition and Fees Deduction, Hope Credit, or Lifetime Learning Credit on education expenses paid for with the IRA distribution.

Answer 2

The penalty, in addition to paying income tax on the amount you withdraw, is an additional 10% of the amount withdrawn if you are under age 59-1/2.

The tax will be calculated on your return at the end of the year. Normally an amount will be withheld when you make the withdrawal, but that might of might not cover all of what you owe. It works just like withholding from a paycheck - if they withhold too much, you get the extra as a refund, otherwise you owe when you file your return. When you file, if your total owed (including the 10% penalty) is over $1000, then you are subject to additional penalties for under-withholding. You can avoid those by either having enough withheld, or by making quarterly estimated payments.

If under the plan rules your matching funds are vested, then you'd keep them, they wouldn't take them back. Check with the plan administrator on this.

No, no breaks for using the funds to pay off tuition costs.

OK, no lectures - you gotta do what you gotta do.

Answer 3

Murkata is correct about tuition costs except that the break from early withdrawal only applies to distributions from an IRA used to pay tuition.
To get there rollover from the 401K directly to an IRA and then take the withdrawal for the tuition. You still pay the income tax but avoid the 10% early withdrawal penalty.

Answer 4

Judy has given enough information about early withdrawal, which is correct. However, I do not agree with his "No, no breaks for using the funds to pay off tuition costs."

There are several exceptions to the age 591/2 rule. Even if you receive a distribution before you are age 591/2, you may not have to pay the 10% additional tax if you are in one of the following situations.

* You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
* The distributions are not more than the cost of your medical insurance.
* You are disabled.
* You are the beneficiary of a deceased IRA owner.
* You are receiving distributions in the form of an annuity.
* The distributions are not more than your qualified higher education expenses.
* You use the distributions to buy, build, or rebuild a first home.
* The distribution is due to an IRS levy of the qualified plan.
* The distribution is a qualified reservist distribution.
Most of these exceptions are explained in IRS Publication 590.

Answer 5

With $25k you are probably going to pay $10,000 in taxes and penalties. They will withhold $5000. You would have to come up with the rest at tax time. Depending on your plan, the employer may keep the matched funds. Read the vesting requirements. No break for paying tuition.

I won't comment on the "weighed my options carefully".....

Answer 6

You will have to pay income tax at regular rates on whatever you withdraw plus a 10% penalty tax. Why not check if you 401(k) plan has an option for a different kind of investment.