Does the 20% Federal Tax Withholding Apply to All 401k Distributions?

No. The plan trustee should only withhold 20% for federal income tax from eligible rollover distributions.

If the distribution is less than $200 for the year, the plan trustee is not required to apply withholding.

The 20% withholding usually only applies to any previously untaxed amount of the eligible rollover distribution (not to any already taxed amount – cost).

However, no withholding is required if the plan directly rolls over (in a trustee-to-trustee transfer) the amount to another qualified retirement plan or IRA. For example, a former employer 401k or pension plan may be directly rolled over to a solo 401k; therefore, the 20% withholding would not apply.

Distributions from designate Roth accounts in 401(k), 403(b), 457(b) or TSP 

Qualified distribution – no withholding because the distribution is not taxable.

Non-qualified distribution – withholding required only from any distributed earnings that the recipient must include in gross income.

Required Minimum Distributions

The 20% mandatory federal tax does not apply to required minimum distributions (RMDs) because RMDs are not considered eligible rollover distributions.

Penalties

A plan trustee may be subject to penalties for failing to:

Properly withhold, deposit or report taxes; and

Electronically deposit withheld taxes. (see for example, Code 6656 and 667267216722 and Treas. Reg 31.6302-1(h))

Additional Resources

Publication 15-A, Employer’s Supplemental Tax Guide

Publication 505, Tax Withholding and Estimated Tax

Publication 575, Pension and Annuity Income

 

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