A couple that makes $75,000 a year took $50,000 out of their retirement plan to cover some expenses they had that year. When the couple took the money out of their retirement plan, the insurance company told them to withhold 15% for taxes and said that amount
would cover the taxes and early withdrawal fees associated with the distribution.
Now, there are two issues with this.
- The first issue is that insurance companies cannot advise their clients on tax-related issues. They are not tax professionals.
- The second issue is that the couple making $75,000 (jointly) is in the 12% tax bracket. By taking a $50,000 distribution from their retirement account (which is included in taxable income,) the $50,000 distribution now moves the couple into the next tax bracket of 22%. This causes the couple to under-withhold from their retirement distribution and now the couple owes an additional $5,000 on their tax return.
Like most horror stories, there is a lesson to be learned out of this. If you are going to take money out of your retirement account, please call us. We can do an income tax projection for you to show how the distribution will affect your taxes, or at the very least, advise you on what to withhold from the distribution. This applies to:
- Regular distributions from retirement plans
- Conversions to Roth IRAs
- Payouts of retirement plans
- If you leave a company, you can have your retirement plan distributed or rolled into a traditional IRA
Taking a distribution can result in a 10% penalty for early withdrawal (before age 59 ½.) For more information on this, please see our blog post on Roth and Traditional IRAs.