By A.J. Gross, C.P.A., E.A.
For years you contributed money to a 401K or IRA. Your employer may have matched your contributions. You now have a good chunk of money saved up in your retirement. Then something happens in your life and you need money. One thought is to withdraw money out of your retirement. But, there are tax consequences. What to do?
There are two main types of retirement withdrawals: normal distribution and early distribution. A normal distribution is withdrawing funds from a retirement account after you reach the age of 59 ?. An early distribution is withdrawing funds from a retirement account before you reach the age of 59 ?. Income taxes will be owed for both normal and early distributions. In addition to income taxes, you may also pay a 10% early withdraw penalty. In most cases, you will pay the 10% penalty for early distributions. You will not pay the 10% penalty for normal distributions.
You are younger than 59 ?. I recommend you evaluate the taxes for early retirement withdraws. For example, you like to cash out your $25,000 retirement. You are in the 15% income tax bracket. When you file your tax return next year, you will pay $3,750 of income taxes and the $2,500 early withdraw penalty. The total amount of taxes owed is $6,250 (3,750 + 2,500). $6,250 is a significant amount!
There may be other options available to you instead of withdrawing from your retirement. Find out if you are able to take a loan out of your retirement. You will not pay taxes for taking out a loan. If you are leaving your employer, you can rollover your retirement directly to another retirement account. There are no taxes for direct retirement rollovers.
You may have no other option but to withdraw funds from your retirement. I recommend paying sufficient IRS and State of Michigan taxes from the withdrawal. A safe amount is 25 to 30% to the IRS and 4.5% to the State of Michigan. These amounts should cover the income taxes and early withdraw penalty. This way you will not get a surprising tax bill when you file your taxes next year.
IRS Circular 230 Disclosure: To the extent this writing contains advice on a federal tax issue, the advice is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.
A.J. Gross, C.P.A., E.A. is President of ALG Tax Solutions. A.J. Gross can be contacted at AJGross@algtaxsolutions.
com or www.ALGTaxSolutions.com.
This was printed in the April 20 - May 3, 2014 edition.