10% penalty for early distribution
I have a client who is in the process of converting traditional IRA over to Roth, systematicly to manage the tax liability. She recently changed jobs and has a 401K at previous employer. If she cashes in the 401K to pay tax liablity on Roth roll-over does she incure the extera 10% Federal tax on the distribution. Thought I read somewhere that money taken out to pay tax liability is exempted front the 10%? Please advise. Thanks.
Permalink Submitted by Alan Spross on Mon, 2011-03-28 20:57
No, there is no exemption from the penaly for tax withholding. However, a client may have another penalty exemption they could apply to the withholding. For example, there is no penalty for distributions directly from a qualified employer plan after separating from service from the employer in the year you turn 55 or later. There are others also including high medical costs etc.
That said, it is generally a bad idea to pay taxes out of a Roth conversion and taking the money out of the 401k is tantamount to the same thing. The total retirement plan assets are reduced by the amount of the tax bill, and taxes and possibly the penalty are paid on distributions to pay taxes. Not a good idea unless client is extremely heavy on retirement assets and light on taxable assets and a conversion is very compelling based on future projections.