When you cash out a 401k, make 401k withdrawals or begin pulling money from your 401k, you will need to pay your 401k taxes. It is important to realize that you will have to pay 401k taxes on your withdrawals so that you can be prepared. Even if the company withholds a portion of the 401k withdrawal penalty for taxes, you may still end up owing more than they withheld. You do not want to be surprised when it is time to file your taxes. If you have a Roth 401k, you already paid taxes on the money, so you will not need to pay taxes on your withdrawals. However, you may still face early withdrawal penalties.
Early Withdrawal 401k Taxes
When you take an early withdrawal for a qualified reason, you will still need to pay the taxes on the money that you take out. The money will be taxed at your current tax rate. This means that if you are at the 15% tax rate, you will pay 15% in taxes in addition to the withdrawal penalty. The company that issues you the withdrawal will not know your current tax rate, and generally they will withhold 20% of the withdrawal to cover the penalty and a portion of your taxes.
Mandatory Withdrawal 401k Taxes
You may face a mandatory withdrawal if you do not have a large amount invested in your 401k. The company may force you to cash out the withdrawal. Once you reach age 70, you may be required to begin taking payments from your 401k. You are required to pay taxes on these withdrawals with a traditional 401k.
Other 401k Withdrawal Penalties
The early withdrawal penalty will apply whether or not you have a mandatory withdrawal or if you are taking a voluntary withdrawal. If you cash out your 401k before you are 59 ½, you need to be prepared to pay the 10% penalty, even if you have a Roth 401k. You need to be aware of the penalty, because it is in addition to the 401k taxes that you need to pay. You will also send it to the IRS.
Getting Professional Help on your 401k Taxes
Since your tax situation is unique, it is important to consult with an accountant when you make the withdrawals. Your accountant can help you determine how much money you need to set aside to cover the taxes. He can talk you through the entire process so that you do not face any surprises when you file your taxes at the end of the year.
Limiting Your 401k Taxes Liability
The only way that you can avoid paying taxes on a 401k withdrawal or cash out is to roll the entire amount into an IRA. You have to do this within 60 days of the withdrawal. The IRA will need to be opened by a qualifying institution. Contact us to learn more about opening an IRA today.