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  1. #1
    Join Date
    Jan 2007
    Posts
    5

    Default 10% Penalty tax on early 401(k) disbursement

    My wife recently started contributing to her employers 401(k) plan. Now we are expecting our first child and she will be quitting her job. Her employer will disburse the 401(k) savings to her less 20% federal taxes. If we rollover the check into an IRA, we must pay the 20% tax difference to avoid the 10% penalty tax. If we cash the check, we are subject to an additional 10% penalty tax. We would like to apply the proceeds to her medical bills. By paying medical bills are we exempt from the 10% penalty tax? Also, we are in the lowest tax bracket. Is it possible to get a tax refund of the 20% federal tax witholdings?

  2. #2
    Join Date
    Oct 2006
    Posts
    15,273

    Default Re: 10% Penatly tax on early 401(k) disbursement

    Quote Quoting quephone
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    My wife recently started contributing to her employers 401(k) plan. Now we are expecting our first child and she will be quitting her job. Her employer will disburse the 401(k) savings to her less 20% federal taxes. If we rollover the check into an IRA, we must pay the 20% tax difference to avoid the 10% penalty tax. If we cash the check, we are subject to an additional 10% penalty tax. We would like to apply the proceeds to her medical bills. By paying medical bills are we exempt from the 10% penalty tax? Also, we are in the lowest tax bracket. Is it possible to get a tax refund of the 20% federal tax witholdings?
    You have confused me a little bit. First you say that you intend to roll the amount over into an IRA, and then you say that you intend to use it for medical bills.

    If you intend to roll it over, then do a direct rollover, don't have the employer issue a check to your wife. That way the 20% won't be withheld.

    If you intend to use it for medical bills, then you are going to be subject to the 10% penalty as well as paying income tax on the proceeds. However, any medical bills in excess of 7.5% of your agi would be deductible if you itemize your deductions, therefore you may get some relief there.

  3. #3
    Join Date
    Jan 2007
    Posts
    5

    Default Re: 10% Penalty tax on early 401(k) disbursement

    Sorry for the confusion. Employees with account balances of $1,000 or less automatically receive a lump-sum payment of their account. She has $700 in her account, so she will receive a lump-sum payment, less taxes. We have 45-60 days to request a rollover to a qualified plan or IRA. To rollover 100% of her distribution, we will need to use our own funds to replace the 20% withheld for taxes.

    Ideally, we wanted to pay medical bills with the distribution. I was asking if there was a way not to have to pay the 10% penalty tax. I guess the answer is "no." I hate taxes in general, but especially penalty taxes!

  4. #4
    Join Date
    Jan 2007
    Posts
    5

    Default Re: 10% Penalty tax on early 401(k) disbursement

    Sorry for the confusion. Employees with account balances of $1,000 or less automatically receive a lump-sum payment of their account. She has $700 in her account, so she will receive a lump-sum payment, less taxes. We have 45-60 days to request a rollover to a qualified plan or IRA. To rollover 100% of her distribution, we will need to use our own funds to replace the 20% withheld for taxes.

    Ideally, we wanted to pay medical bills with the distribution. I was asking if there was a way not to have to pay the 10% penalty tax. I guess the answer is "no." I hate taxes in general, but especially penalty taxes!

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