Most taxpayers facing financial hardship might be forced to turn to their retirement savings as a last resort to either partially or fully supplement their living expenses. However, this is normally a hard decision to make, due to the high early withdrawal IRS taxes and penalties. It is very likely that any withdrawal made from IRAs, 401Ks, and other qualified pension & retirement plans will attract a federal tax.
If you had a pension plan with a previous employer, you are possibly wondering if you should just roll it over into a traditional IRA or new plan. Most retirement plans are designed to rollover from one trustee to another. In such cases, the taxpayer receives a 1099R indicating the rollover but with nil taxable amount. As much as this might appear to be an ideal way to dodge paying taxes on your retirement savings, it may on the other hand, not appeal to some taxpayers who need their money immediately.
In case of urgent financial need, the pension plan will generally hold back 20% Federal withholding and a set percentage for the state. It is a huge blunder to generally assume that distributions attract all federal taxes. In real sense, only about 10% of the 20% federal withholding goes to taxes, while the other 10% might be an early withdrawal penalty. The definite tax amount can be established based on their marginal tax rate. Example: If you are in the 15% tax bracket, you will possibly pay a 15% tax on distribution. The withholding doesn’t cover all early withdrawal penalties and resultant taxes, it is therefore, important to contact your tax pro with all necessary income details to calculate the most accurate tax estimate.
Modes of withdrawals vary from one plan to another. Most of them however allow taxpayers to withdraw a lump sum distribution, or stretch them over a specific duration, or both. With such a distribution, all taxable income from the withdrawals is squeezed into a single year. It is very unlikely that you will be subjected to any withdrawal penalties, but you may have to pay normal taxes. However, you might be baffled if a lump sum withdrawal pushes you to a higher income tax bracket, digging further into your finances. Other than the lump sum, there are other factors that may affect your taxes like:
· Wages before retirement
· Retirement payouts
· Severance payouts
· Monthly pension payments
· Social Security benefits
All these factors must also be looked into before making a withdrawal. You can evade some of the taxes by taking the retirement savings as annuity, but this will also depend on how well you plan your income.
It is very important to plan and weigh all available options and consequences of each action before taking funds out of a retirement savings account. Talk to a tax pro who will help you understand the fundamental taxes on withdrawals, review your income, offer help on your W-4, tax estimation, and even clarify on various rollover options.