My father, who was born in 1930 has just finally retired from his full-time job on December 31, 2008. He has never touched his 401k, which is now around $270,000 and all of it is in a money market account.
From what I understand, since he was born before 1936 and he never touched
his 401k that he can choose to do a lump sum distribution using IRS form
4972 during the 2009 calendar year.
Our questions are:
1) He resides in New York City. This means that his lump sum will be taxes by the Federal Government, State and City. Is this correct?
2) What / how can we figure out what are the taxes owed on this total amount?
3) If he does take a lump sum, will he get the full amount from the
401k folks and then pay the taxes at the end of the year, or all deductions (for taxes) are made before he is sent the money?
4) If he earns $50K (pension, social security) in 2009 and on top of he takes out the $270K, will he then be considered making $320K for the year
2009 or will his $50K will be taxed at his normal rate and the $270K will be taxed at the special "form 4972" rate?
5) What is the difference between form 4972-S and 4972-T ?
6) What is this "10-year average" qualification that I see people asking about?
Thank you very much for your help with this matter! I am trying to get some ideas of what he will be dealing with.
When discussing income and taxes, some income is taxable income.
Some is non-taxable income.
Some is tax exempt income.
And in this case, Lump Sum Distribution from a qualified employer plan, you have the case of taxable non-income.
This lump sum distribution income is not counted as income, does not add to AGI. Does not add to the taxability of social security income.
But it does produce a tax advantaged income tax. That's what the lump sum distribution form does for you.
I cannot comment on state/city income tax. And the business of ten-year averaging is done for you by just following line by line instructions for the form.
The 401k plan manager might withhold income tax, but why not ask them?
Whether it makes sense to lump sum average -- it often does -- is something you'll have to try. If it works well for you, go for it.
The only IRS form is Form 4972. I think you are looking at a list of forms in some tax software, such as TurboTax. The software has two copies of Form 4972 because the form applies to only one individual, even on a joint return. So a joint return could have two copies of the form. Form 4972-T is Form 4972 for the Taxpayer - the first or only person listed on the return. Form 4972-S is Form 4972 for the Spouse - the second person listed on a joint return.
Since he is over 70, there is no early withdrawal penalty. There is no longer a 10 year averaging .
If he takes a distribution he will get a 1099R and and it will be included in his gross income. Note that if there is after tax money in his 401K then that will not be included in the gross income.
With his other income he will be hit hard with taxes. (might lose half of his 410k) He might want to consider first taking out any after tax dollars and then roll the rest into an IRA and taking out a bit ever year. A trustee to trustee rollover does not result in a taxable event.
The 401K plan will withhold 20% for the IRS and ? for both NY and NYC unless told otherwise.
Don't know if NY taxes 401k and IRA withdrawals but CA does.
Also not of SS is taxable. There is a worksheet.
A half hour with a real (not H&R) tax person is well worth it.
As the IRS page Art referred you to explains, this is a complicated area because your dad is in the age group (born before 1936) that still has several options as to how the distribution will be taxed. You really have to figure the federal income tax two or three different ways to determine which election works best for a particular taxpayer's situation. In addition, New York State and New York City impose separate taxes on lump sum distributions using a rule that is different from the federal treatment. I would advise your dad to consult a tax professional in New York before taking the distribution.
Does he need all the money right away, or could he roll it over from his employer into a rollover IRA? Spreading the money received over a few years, even 2 or 3, could cut his tax bracket considerably..
1) He resides in New York City. This means that his lump sum will be taxes by the Federal Government, State and City. Is this correct?
Yes Look at the NY tax form IT-230 and its Instructions to see howt they tax a 4972. It looks like NKYState and City total about $3,000.
2) What / how can we figure out what are the taxes owed on this total amount?
The instructions for form 4972 and NY form IT-230 tell you how to figure the tax..
The 4972 tax for a $270,000 Lump Sum Distribution will be $56,770, for an average tax rate of 21%. If he made any After-tax Contributions, deduct them from the $270K. He cannot roll over to an IRA AND take a
4972 DIstribution. He cannot take only part of the $270K. He can take a 4972 separately on his pension if he wants to lump sum it (if allowable). The 4972 Instructions are misleading regarding prohibiting more than one 4972. I personally took 3 for different plans.
You should compare this one-time 4972 tax with the tax on RMD's (His RMD amount of ordinary income would be about $14,000 in 2009 and increasing each year). The RMD adds to his AGI and is taxable ordinary income at his tax bracket. When he dies any remainder is taxed to his heirs at their tax bracket.
The 4972 is a lump sum of tax and does not add to his AGI nor ordinary income tax bracket, nor add tax on heirs, however the subsequent earnings on the lump sum are taxed as any investment would be.
3) If he does take a lump sum, will he get the full amount from the
401k folks and then pay the taxes at the end of the year, or all deductions (for taxes) are made before he is sent the money?
20% withholding will be taken from the lump sum, or about the amount of 4972 taxes due.
4) If he earns $50K (pension, social security) in 2009 and on top of he takes out the $270K, will he then be considered making $320K for the year
2009
No, it does NOT effect his ordinary tax nor income since it is a just another tax on his 1040 line 41(b) and doesn't enter into his AGI nor AMT.
or will his $50K will be taxed at his normal rate and the $270K will be taxed at the special "form 4972" rate?
Yes
5) What is the difference between form 4972-S and 4972-T ?
Same form in tax programs for "Taxpayer" and "Spouse".
6) What is this "10-year average" qualification that I see people asking about?
That is it. Lump Sum form 4972. There used to be 5 year averaging but it is no longer available.
Thank you very much for your help with this matter! I am trying to get some ideas of what he will be dealing with.
It is very straight-forward. Just fill out the form 4972 and enter the tax on his 1040 at line 44(b). NY is a bit more complicated but much of it won't apply to him as there is no annuity nor Long Term Capital Gain. good luck
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