20% Withholding

By Marvin Rotenberg, IRA Technical Expert

Generally, when rollover eligible assets are distributed from a qualified retirement plan, 403(b), 401(k) or 457(b), to the participant, instead of a direct rollover to an eligible retirement plan, the payer must withhold 20% for federal income tax. And if applicable any state withholding tax. The amount withheld will be remitted (by the payer) to the federal and or state government as an advance payment of taxes on the individual’s behalf. 20% withholding does not apply to IRAs.

If the plan participant wants to rollover the entire distributed amount upon receipt (minus 20%) they will need to make up the amount withheld for taxes out of pocket. When they file their income tax return they can apply for a refund for the amount withheld. The withheld taxes will either increase their federal tax refund or reduce federal taxes owed for the year. The same would apply to any state income tax withheld.

Keep in mind that money distributed from a qualified retirement plan may also be subject to an early distribution penalty of 10% if you were under age 59 ½ (or, in some cases, age 55) when the distribution occurred. If you intend to rollover the distribution to an IRA it is always better to do a direct transfer. Have the plan distribute the money directly to your IRA. This is called a trustee-to-trustee transfer. This will eliminate any mandatory withholding.