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Lane, JD, CFP, MBA, CRPS
Category: Tax
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Experience:  Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
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401k/IRA early withdrawal specific tax implications. Hello

Resolved Question:

401k/IRA early withdrawal specific tax implications.

Hello experts. We are going through divorce, amicably. We have no choice but to liquidate our retirement savings in order to solve our living situation in a way that doesn't upset our kids (or does so as little as possible).

We need to estimate, with some accuracy, the tax implications of the following transaction:
(1) $265,800 in a qualified 401k
(2) $100,000 in a non-qualified retirement plan
(3) $205,000 in an IRA

All these funds to be transferred to the ex-spouse. Both (1) and (2) will *not* pay the 10% early distribution penalty fee (as we have QDROs for all of them). (3), the IRA, will pay the 10% penalty fee.

Assume there is no other income on the receiving spouse, and all the monies above are distributed into her bank savings account in their totality, and in one lump sum (or three, as the case might be).

Spouse is 40 years old, has no other income, filing SINGLE (for simplicity purposes).

What is the tax the spouse has to pay for, say 2012? Would it be much different for 2013?

Thanks in advance
Submitted: 1 year ago.
Category: Tax
Expert:  Anne replied 1 year ago.
Hi

Thank you for your question. Although I am going to use the 2013 information (since 2014 figures have not been finalized yet) but we will be very close.

The tax rate tables are set up so that you use your TAXABLE income (after your standard deduction and personal exemption amount have been subtracted)

Your spouse will be in the highest tax bracket which is 39.6%, plus the 10% penalty on the IRA

Please see below:

http://www.forbes.com/sites/kellyphillipserb/2013/01/15/irs-announces-2013-tax-rates-standard-deduction-amounts-and-more/

You will want to use the chart named "Individual Tax Payer"

I truly hope this information is helpful but please do not rate until you are satisfied. If you want to click on 1 or 2 just click on the continue to work with me button instead. You will then be able to add any other info or respond to what I have posted so far. Rating 3-5 gives me credit and a good rating but you can still converse with me.

Customer: replied 1 year ago.
Anne,

Thanks much for your reply, but I think I need a bit more clarification, and some concrete numbers please.

I went to the URL you mention above, and did some calculations... As follows.

(a) The IRA is 205k, and so right off the bat there's a 20.5k fee (10% penalty)
(b) Then, the total gross withdrawn is 571k
(c) According to the tables, I should owe 116k PLUS 39.6% of the remaining (571-400 = 171).
(c) When you put it all together, you have:
- 20500 penalty
- 116163 from the table
- 67716 (39.6% of 171k)

Or, all together: $204,379

But, that does not include California taxes (State taxes), which I assume my spouse will also have to pay, correct?

So, two follow-up questions:

Q1: Are my calculations above correct?
Q2: Given this scenario, what are the CA taxes?

Thanks
Expert:  Anne replied 1 year ago.
I'm afraid that its been a long day and I really need some rest.

Would tomorrow late morning/early afternoon be soon enough to receive the answers?

If you have a time constaint , then I can "opt out" which puts this back on the open board
Customer: replied 1 year ago.
Tomorrow is fine Anne. I am really looking forward to your answer. Also, when you respond, maybe it is beneficial for us to file as Married for 2013 (we still have that option) and if so please advise.

Thanks again,
Expert:  Anne replied 1 year ago.
I apologize. I just noticed that you are from CA and would like the information for CA also.I have absolutely no problem giving you all the information you need for Federal, but I'm afraid that Community Property States are not my longsuit.I may either "opt out" all together, which puts this question back on the open board for another expert who would know both federal and CA, or I can answer the Federal only portion of the question, and you ca file a new question for the CA side.The choice is yours.......and I completely understand that you must do what is best for you, so if you want me to "opt out", its not a problem.
Expert:  Anne replied 1 year ago.
I have "opted out" so that this question goes back on the open list so that you can get a complete answer

Again, thank you for your patience, and thank you for using justanswer.
Expert:  Arthur Rubin replied 1 year ago.

I'm not sure I'll be able to answer your question, but I have a few questions which may be required in order to provide a complete answer.

 

  1. Were you married throughout the time you were working and earned the retirement funds in question? If not, more details will be required.
  2. Were you living in California throughout the earning periods in question?
  3. Are there differences between the California deductions and the Federal deductions on the IRA? (I think that only applies to earnings before 1983, but I'd have to check the exact date.) In other words, was there a California adjustment to the IRA deduction?
  4. Are you sure that the QDRO removes the 10% penalty (plus 2.5% for California)? My recollection is that it doesn't prevent the penalty, but only affects who has to pay it. I'll need to research this further, if I can answer the question.
  5. Is the working spouse separated from service (in other words, no longer employed)?
  6. What is your age? (The age of the working spouse, not the receiving spouse.)

 

Again, I'm not sure I'll be able to answer the question, even if all this information is provided. But I'm sure that I'll need 1-3 answered, and 5 and 6 might affect the 10% penalty, and whether there are exemptions from the penalty. Also, if you are over about 75 (unlikely, but I have to ask), and you liquidate the entire retirement plan, you might be eligible for income averaging for your Federal taxes.

 

Other details which may affect estimated tax penalties are your previous-year Federal and California taxes, and any withholding you may have had this year.

 

I'm going to be off-line for at least 12-14 hours. If this is not acceptable, you can opt me out, or I'll opt out when I get back.

Customer: replied 1 year ago.
1. Yes
2. Yes
3. No idea, I am not a tax expert :-)
4. Yes, sure. Only the IRA pays the penalty
5. No, still working
6. 43

Hope this helps.
Customer: replied 1 year ago.

No answer?

Expert:  Lindie-mod replied 1 year ago.

Hello,

I'm Lindie, and I’m a moderator for this topic. I've been working hard to find a professional to assist you right away, but sometimes finding the right professional can take a little longer than expected.

I wonder whether you're ok with continuing to wait for an answer. If you are, please let me know and I will continue my search. If not, feel free to let me know and I will cancel this question for you. Thank you!

Best,

Lindie

Customer: replied 1 year ago.
It is ok. I can wait a bit more.
Expert:  Lindie-mod replied 1 year ago.

Hello,

Thank you, XXXXX XXXXX continue to look for a professional to assist you. Please let me know if I can be of any further assistance while you wait.

Best,

Lindie

Expert:  Lane replied 1 year ago.

Hi Rick,

I can help here.

First, you are right about the 10% penalty ... In your situation that's about all the QDRO protects (since the intent is to distribute).

Do remember, however, that the receiving spouse can roll into their own plan and continue that tax deferral (might make some sense, because there would only be a taxable event as the money is distributed, and if it might not be needed all in one tax year the receiving spouse can defer some of that taxation).

However, another aspect of the QDRO process is that if the receiving spouse decides to roll the assets (must be within a 60 day window), NOW the 10% penalty applies again - to the receiving spouse - as the assets are distributed.



So THAT decision turns on how quickly the money might be needed.

In terms of your tax calculations, your federal calculations are spot on.

THe difficulty in calculating your CA taxes are that we don't know that you wife's other income might be.

You show an understanding in the calculations that whatever taxation comes from the distributions will be at the margin (on top of the other income for the year).

Can you provide a ballpark estimate of both you and your wifes OTHER income (income other than the IRA and 401(k) distributions) as it will look in 2013.

Then if will be possible to estimate each of your CA income tax.

FYI, here are the CA rates for 2013, for single taxpayers:

For earnings between $0.00 and $7,124, you'll pay 1.00%For earnings between $7,124.00 and $16,890, you'll pay 2.00% plus $71.24For earnings between $16,890.00 and $26,657, you'll pay 4.00% plus $266.56For earnings between $26,657.00 and $37,005, you'll pay 6.00% plus $657.24For earnings between $37,005.00 and $46,766, you'll pay 8.00% plus $1,278.12For earnings between $46,766.00 and $1,000,000, you'll pay 9.30% plus $2,059.00For earnings over $1,000,000.00, you'll pay 10.30% plus $90,709.76


Let me know ...

Lane

Customer: replied 1 year ago.
Lane, the non IRA funds were already disbursed into her savings account, so that ship has sailed. As far as other income, figure 450k for me and 36k for her.
Expert:  Lane replied 1 year ago.
Rick,

For her, the marginal bracket is 6%

"For earnings between $26,657.00 and $37,005, you'll pay 6.00% plus $657.24"

.. so the tax on 36,000 is 6% x (36,000 - 26657) = 560 ... + 657 = 1217



For you, the marginal tax bracket is 9.3%

"For earnings between $46,766.00 and $1,000,000, you'll pay 9.30% plus $2,059.00"

.. so the tax on 450,000 is 9.3% x (450,000 - 46766) = 41850 ... + 2059 = 43909


Then the 265,800 in a qualified 401k and the $205,000 in an IRA would be taxed (I'm assuming they are yours) at the 9.3% bracket (because those dollars still total, along with your other income, less that 1,000,000) so that's an additional 43784 in CA state income tax.

If those were all your accounts, then the only tax she will see is whatever interest income or dividend income those dollars create for her during the tax year.

Now, tell me about the non-qualified plan.

Taxation on those vary depending on a plethora of factors. What type of plan is it?

Lane
Customer: replied 1 year ago.

Lane, thanks for these answers. I have to admit I am a bit overwhelmed by all the numbers. At the end of the day, I am looking to get a "net" value of (1), (2), and (3) in my original email, once my spouse has paid all her taxes (which means, both Federal and CA). Would you be able to sum everything up and provide the "net"?


 


In the non-qual plan you find the following:


 





"The Plan is not qualified under the Internal Revenue Code of 1986, as amended (the “Tax Code”). It is intended to be an unfunded capital accumulation/retirement plan maintained primarily for the purpose of providing deferred compensation for a select group of highly compensated management employees, as described in Section 401(a)(1) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). Although the Plan is subject to ERISA, it is exempt from the funding, participation, vesting, and fiduciary requirements of ERISA. "


 


 


"





The Plan is a non-qualified deferred compensation plan and is not intended to qualify under Section 401(a) of the Tax Code. You will be subject to federal and state income tax in the year or years that you eventually receive a distribution from the Plan. Plan distributions will be taxed as ordinary compensation income. The distributions are not eligible for rollover to IRAs or to tax-qualified plans, but they are also not subject to penalties that can apply to early distributions, excess distributions or excess accumulations in qualified plans. "


 


"






  1. The recipient of a distribution from the Plan will be subject to federal income tax in the year of such distribution on the amount of the distribution. When you receive money from the Plan, the company is required to report your distribution amounts to the IRS.












Amountspaidtoyouaresubjecttowithholdingtaxes.Federaltaxesarewithheldatthesupplemental


rate.
Amounts paid to you are not subject to FICA taxes. Amounts credited to your Plan account are subject to FICA tax at the time they become fully vested, rather than at the time of distribution.


DistributionsmaynotberolledovertoanIRAoranotherretirementplan.






 


10








State and Local Taxes


Under federal law, only your state of residence at the time you receive a distribution may tax that distribution if either: (A) your account is distributed in installments over ten years or more; or (B) the distribution is from a non-qualified plan that solely provides benefits in excess of tax law limitations governing qualified plans.


Please consult a professional tax advisor concerning state taxation of your Plan distributions. "


 


 








I am hoping that tells you something :)


 


Thanks in advance for your help.


 


 




Expert:  Lane replied 1 year ago.


Sure RIck.


Given the information that you've provided on the non-qualified plan, I'll assume that the distribution is taxable and that you are taking a full distribution.

And, again, I'm assuming that the plans are all yours, so there will be no tax to your wife ... other than the tax on any dividends and interest from the dollars in the non-qualified accounts.


(1) $265,800 in a qualified 401k
(2) $100,000 in a non-qualified retirement plan
(3) $205,000 in an IRA

Every one of these will be added to your taxable income, so at $450,000 + 265,800 + 100,000 + 205000 = 1,020,000


If you'll look here: http://www.tax-brackets.org/californiataxtable

you'll see that for earnings over $1,000,000.00, you'll pay 10.30% plus $90,709.76

So that's (10.3 % x 20,000) + 90,709 = 92769 in CA taxes

Again, if these were all distributions form YOUR accounts your wife will see no additional income taxes from the distributions.

Now, if you'll look at the tax estimator at the site above, I believe you've underestimated your federal taxes (again based on all three distributions being taxable in the same year):

 

Federal Tax:$326,358.50 State Tax:$92,273.71 Total Tax:$418,632.21

 

The small difference you see in my state estimate and the estimate derived at the site I've linked above is no taking the CA standard deduction and exemption.

 

 

 

Customer: replied 1 year ago.

Lane,


 


But all these accounts and funds were transferred to her as her sole property as part of our separation? Is it still my income? If we still file "married filing jointly" (which we have a chance to do), does that help our situation any?


 


But, irrespective of the fact above, the numbers look like:


 


Out of the $570,800 withdrawn from the plans, we need to pay: $204, 379 in Federal Taxes *plus* $92,769 in CA taxes; for a wonderful grand total $295,148, or 51.7%


 


Is that right? How on earth could the taxes be so incredibly high?


 


In my last taxes, with a high salary (stocks sold etc) of around 800k, the net effective rate (including federal and state) was close to 37%. I understand that this would put us over 1m, but to go from 37% to ~52% it seems rather excessive, no?


 


Sorry, trying to process the sticker shock.


 


Thanks,

Expert:  Lane replied 1 year ago.

But all these accounts and funds were transferred to her as her sole property as part of our separation? Is it still my income? If we still file "married filing jointly" (which we have a chance to do), does that help our situation any?

 

SO sorry to be the messenger Rick but on these retirement plans the taxable event is when they are distributed, when they come out of the shell, so to speak, of the IRA, 401(k) and in the case of THIS non-qualified plan, when it's distributed, as well.


The money was simply given to your wife after you distributed it. Gifts between husband are not taxed ... (and if you did so after the divorce, there's still a $5,250,000 exemption on gift taxes)


So, the 265,800 + 100,000 + 205000 are simply added to your already existing 450000 of income for the year ... so distributing them all in the same year means that you made 1,020,000 for the year.


AND I've just realized that the estimator didn't add the 10% on the IRA portion.


(I hate this part of the job, but hopefully having all the facts, will help you "see around some corners." )

 

 


But, irrespective of the fact above, the numbers look like:


Out of the $570,800 withdrawn from the plans, we need to pay: $204, 379 in Federal Taxes *plus* $92,769 in CA taxes; for a wonderful grand total $295,148, or 51.7%


Again, sorry, but if you distribute All three in the same year PLUS a salary of 450,000 you've underestimated ... NOW I used simply a standard deduction, IF you itemize that will reduce the taxable income some.

 



Is that right? How on earth could the taxes be so incredibly high?


Two things need to be pointed out:


(1) I'm estimating TOTAL taxes (including the 450,000) not just the tax on the distributions themselves


(2) These are all retirement plan contributions, which are taxed as ordinary income. The stock sales you mention were taxed at the lower capital gains rates.


Filing jointly will most definitely reduce the taxes, (higher standard deduction AND higher threshold for the brackets)


Federal Tax:$315,324.50 State Tax:$89,471.63 Total Tax:$404,796.13

That's less that 40% effective

To make you fee better about the numbers, go to the bottom of this page and use the tax estimator:

http://www.tax-brackets.org/californiataxtable

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 4503
Experience: Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
Lane and other Tax Specialists are ready to help you
Expert:  Lane replied 1 year ago.

Thanks so much RIck.

Let me know if I can help further.

By the way ... commendable the way you're doing things (in this guy's opinion)

.. have a 12 yr old to kiss and make go to bed now.




If you'd like to work with ME again just say "For Lane only," at the beginning of your next question.

Thanks again,

Lane

Customer: replied 1 year ago.

Lane,


 


Just closing the loop, no follow-up required from you.


 


I went to my CPA, she ran all kinds of pro-forma analysis and, in the end, you are right... I will pay taxes at full clip as if I had gotten the money for myself.


 


Gotta love this system! :-)


 


In any case, thanks very much for taking the time to explain it to me.


 


--Rick

Expert:  Lane replied 1 year ago.

You're very welcome....

Can't say I'm surpirsed :)

But thatnks so much for the feedback

P { margin-bottom: 0.08in; }A:link { }

If you'd like to work with ME again just say "For Lane only," at the beginning of your next question


Thanks again
Lane

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