Question

On April 15, Richard (age 57) was fired from his employer of 25 years due to poor performance.. During his 25 years of employment, Richard contributed $200,000 to his traditional 401(k) account. When Richard was fired, his 401(k) account balance was $700,000 (this included both employer matching and account earnings). Richard immediately withdrew $50,000 to use for expenses.. What amount of tax and 10% early distribution penalty must Richard pay on the $50,000 withdrawal if his ordinary marginal tax rate is 32 percent?

Answer:

Answer 1

If you withdraw money from your 401(k) account before age 59 1/2, you will need to pay a 10% early withdrawal penalty, in addition to income tax, on the distribution. For someone in the 24% tax bracket, a $5,000 early 401(k) withdrawal will cost $1,700 in taxes and penalties. There are a couple of exceptions to the 401(k) early withdrawal penalty. For example, if you lose or leave your job at age 55 or later, you won't have to pay the 10% penalty on withdrawals from the 401(k) associated with the job you most recently left.

Exceptions:

You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:

• You become totally disabled.
• You are in debt for medical expenses that exceed 7.5 percent of your adjusted gross income.
• You are required by court order to give the money to your divorced spouse, a child, or a dependent.
• You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
• You are separated from service and you have set-up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59 1/2, whichever is longer.)

Therefore richard is not required to pay any tax on 50,000$ withdrawn as he falls under the category of termination of his service at the age(57) more than 55 years.

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