A 55 year old recently received a $30,000 distribution from a previous employer's 401k plan, minus $10,000 withholding. Which federal taxes apply if none of the funds were rolled over?

• A. Only income taxes on $30,000
• B. Only income taxes on $20,000
• C. Income taxes plus a 10% penalty tax on $30,000
• D. Income taxes plus a 10% penalty tax on $20,000

Answer: (C)

When you take a distribution from a 401(k) before age 59½ and you don’t roll it over, the full distribution is included in your gross income and taxed as ordinary income. In addition, a 10% early withdrawal penalty applies to the distribution amount unless an exception applies. Since the person is 55, none of the common exceptions apply, so the 10% penalty is charged.

The distribution amount subject to tax is the full $30,000. The $10,000 that was withheld is just prepayment of tax and doesn’t change the amount that is taxed or the penalty. So you owe income tax on $30,000 plus a $3,000 (10% of $30,000) early withdrawal penalty. The withholding helps offset some of the tax due when you file, but the tax and penalty are calculated on the entire distribution.