any tax people?

[mom-from-missouri]

OK, so I a helping a friend from church--i think she needs to file and extension and get a tax person...but....

she was in foreclosure and took out 129,400 from her 401k/retirement to stop the proceedings. vanguard told her they would withhold all the taxes. according to the 1099-r, they took out 10% for fed and $7764 for state taxes. her tax software and my turbo tax, both say she owes an additional $38,000 in federal taxes (before this 1099r is entered, she is getting a $150 refund from fed). Can that possibly be correct??? she is 38 years old. i saw somewhere where if you take money out, they are not supposed to let you contribute to your 401k for the next 6 months, but her employer still takes it out of her paychecks, according to her stub....she did this as a hardship withdrawl, and vanguard told her she should have no additional taxes. so either they told her wrong, sent the wrong form or we are nuts. which is it? she compared her 1099r to someone elses 1099r who did a withdrawl for the same reason, and they have a different distribution code--hers is a 1, theres is a 2.....

[MonkeyMama]

I haven't dealt with hardship withdrawals, so am not an expert.

That said, I think the 1099 is correct. I am not surprised she owes that much in taxes.

The 401k distribution is taxable as income. The large amount will push her into a much higher tax bracket than usual. So, 10% sounds like hardly enough tax withholding.

She needed tax advice when she took the distribution, basically.

Anyway, it looks like you complete Form 5329 to claim the hardship and ask the IRS to remove the 10% penalties. Completing the form may just take off any penalties. May be another form, similar, for the state. This might help lower the amount she is coming up with.

The eligibility for hardship can not be determined by Vanguard, so it sounds like they were correct to issue the 1099 as a fully taxable and penalized event. Code 1. Taxpayer files form 5329 to prove it is a hardship and not subject to penalty.

To be clear - the hardship should erase the penalties, but she will still owe a large amount of taxes on the money. This is assuming she actually made all the hardship requirements.

[SnoopyCool]

Code 1 means there was no known exception. Code 2 means that there is an exception. I *believe* it depends on whether or not her 401k allows for hardship distributions. If it did and they coded it wrong (and I have seen stranger things this tax season with 1099-Rs, believe me), then there's some hope there.

At any rate, extensions are free to file at H&R Block right now, and she can go in and get some free advice on what to do next while she's there. If she goes this route, ask for the senior tax preparer in that office.

[Like2Plan]

Originally Posted by mom-from-missouri

OK, so I a helping a friend from church--i think she needs to file and extension and get a tax person...but....

she was in foreclosure and took out 129,400 from her 401k/retirement to stop the proceedings. vanguard told her they would withhold all the taxes. according to the 1099-r, they took out 10% for fed and $7764 for state taxes. her tax software and my turbo tax, both say she owes an additional $38,000 in federal taxes (before this 1099r is entered, she is getting a $150 refund from fed). Can that possibly be correct??? she is 38 years old. i saw somewhere where if you take money out, they are not supposed to let you contribute to your 401k for the next 6 months, but her employer still takes it out of her paychecks, according to her stub....she did this as a hardship withdrawl, and vanguard told her she should have no additional taxes. so either they told her wrong, sent the wrong form or we are nuts. which is it? she compared her 1099r to someone elses 1099r who did a withdrawl for the same reason, and they have a different distribution code--hers is a 1, theres is a 2.....

Looking at the tax tables, if her taxable income was 129,400 alone the tax would be around $24,700--but it is probably higher than that because she has her regular income--if her regular taxable income is over 100K, the tax rate for a married person for the amount over 100K is 25%. That would be $32350. Plus a 10% penalty for early withdrawl. Plus penalties for underwitholding. Plus, she may have been pushed into AMT territory.

Did she use the entire amount (129,400) to prevent the foreclosure?

[Scanner]

I am not a pro-CPA or pro-HR Block or pro-Tax Attorney or pro-Bankruptcy Attorney but in this case, I am going to think the best professional she should have punted this to should have been a

A. Bankruptcy Attorney
B. CPA

working in tandem.

Now, I say this when I personally use a Tax Advisor for my small business (no employees/payroll, minimal bookkeeping) from HR Block (he's a few hours short of being an enrolled agent).

I think the bankruptcy atty. would have addressed the emotional component. . .I know she feels like she should have tapped her 401(k) to pay for her house in foreclosure. . .but you know what I say to that? "F" that.

I believe Roth's, SEP-IRA's, and traditional IRA's are protected assets in the event of bankruptcy. She should have filed. Banks will use a CPA to write down the loss of the mortgage - why shouldn't she get every legal advantage to her under law?

So now. . .they get the house (+ late fees) and they get retirement moneys?

All this being said, even a good tax advisor from HR Block should be able to tell you what happens when you raid pensions. My HR Block guy was telling me how a family did such a thing for college and really suffered and all it took was a phone call to him and he could have saved them 1000's.

This is way beyond you. Way beyond me. She needs professional help.

[jpg7n16]

No need for a bankruptcy attorney, could double check with a CPA, or an IRS enrolled agent in your area.


The increase in taxes was about $38,150. Divide that by the withdrawal amount (129,400) and you get a marginal rate of about 29.36%.

Look at marginal rates here:
2010 Tax Rate Schedules: Marginal Ordinary Income Tax Brackets for Year 2010

Given the income amount from that distribution, it's very easy to see why she owes so much. The tax increase looks about right - they only withheld 10% (took care of the 10% penalty), so no actual tax was withheld on the withdrawal amount.

Looks like this withdrawal is spread across the 28% bracket (predominantly) and pushed her slightly into the 33% bracket.


..... and also easy to see why we advocate never touching 401k money until retirement.