401(k) Early Withdrawal

Q. I borrowed $15,000 from my 401(k) in Feb, 09. In May, 09, I was laid off from my job. My only options for the loan were to pay it in full (not going to happen) or default. They would NOT allow me to continue making payments and would not transfer the loan to my new employer!  Anyway, can you tell me how to calculate the penalty that I will be charged when i file my taxes for 2009?

A. Generally, the fees charged for early withdrawal amount to a 10% penalty.  Sometimes the vendor of the company’s 401(k) plan will take the 10% penalty from the proceeds when someone cashes out a plan.  However, in your situation, there was no way to know this would eventually be considered a cash out.  Because the contribution to the plan is pre-tax for federal purposes, you will pay regular income tax on the withdrawal as well.  This means the calculation of total income on your tax return for 2009 will include the loan balance that was forgiven.  Your taxable income will be higher than it would have been without this dollar amount.  How much higher is to be calculated between you and your accountant or tax preparer. You can run a calculation for estimated annual liability using Publication 919 from the IRS. Beware!!! This process is like completing a simulated tax return.  If you miss one number in your calculation, the whole thing could be wrong.  This of course does not help you find your tax liability number.

If you find after working through Publication 919 that you will be short on your tax liability payments, you can adjust your withholding with your new employer for the remaining periods in the year.  This is a good idea to ensure that you don’t have any underpayment penalties at tax time.  Also, you can estimate what your check would look like using any changes you might make to your withholding allowances using the free Paycheck Calculator at PaycheckCity.com.

SIMPLE 401(k) vs 401(k)

Q. I own a small business and have 5 employees.  I am looking to expand to company and need to offer some kind of retirement plan for my employees.  401(k) plans are really expensive and I don’t know much about SIMPLE plans.  What do I choose?

A.  This is a very important question for small business owners to think about.  When you are ready to start offering benefits to your employees, some types are better suited for larger employers and some are specifically designed for smaller employers.  The biggest difference between these types of plans is the testing requirement.  In traditional 401(k) plans, employers need to ensure that the plans do not become “top heavy”.  That is, key or highly compensated employees are taking advantage of the plan more than regular employees.  If a 401(k) plan becomes top heavy, the plan risks losing it’s tax benefits.  In a smaller business, an employer may wish to take full advantage of the retirement contributions on behalf of him or herself while employees may not want to or be able to.  By removing the testing requirement, you are providing the plan without the risks.

Limits on the SIMPLE plans are a bit lower ($11,500-Simple vs $16,500-traditional for 2009).  There are also limits to the amount that an employer can contribute to an employee’s account (3% of employee compensation-Simple vs 25%-traditional).  If your employee population reaches 100, that employer is no longer eligible for the SIMPLE type plans.

It is a great idea to offer a retirement savings plan to your employees.  As an employer, you can choose to match or not match the contributions which makes the plan that much more valuable.  It is a great way to attract and retain the best talent.

More Tax Relief?

1) The IRS just released a press release regarding a new deduction for the 2008 and 2009 tax years.  If you pay real estate taxes, but don’t have enough deductions to itemize on Schedule A, you can still deduct some of the real estate tax you pay on your home.  The amount can be up to $500 per person or $1,000 for those that are joint filers.  This means if you are married filing joint, your standard deduction could be increased from $10,900 to a maximum of $11,900.  Depending on your marginal rate, this could equate to a significant tax savings.  Make sure you talk to your tax preparer about this deduction.  There is some fine print regarding qualifications for this deduction.

2) Don’t forget about the Retirement savings credit. If you fall into one of the following categories, you may be able to take an additional credit against your tax liability for contributing to a retirement plan:

• Single with income up to $26,500
• Head of Household with income up to $39,750
• Married Filing Jointly, with incomes up to $53,000

This is a great incentive to establish and contribute to a retirement plan.  You can contribute for the 2008 tax year until April 15 of 2009.  Check with your tax preparer or financial advisor regarding the best type of investment for your situation.

Don’t miss out on these tax savings items.  There are many credits and deductions available in the tax code.  This is yet another reason to have a licensed tax preparer take care of your tax return.  You don’t want to miss out because you didn’t know that they existed!

The Sky is Falling…Or Is It?

Q. I have taken a 50% hit on my 401(k) account this year because of the market contraction.  I’m thinking of just pulling all the money out and investing in a rental property instead.  Is this a good idea? I live in the southwest where real estate has really dropped anyway. I’m not 59.5 yet either.  I am in the 35% bracket.

A. Now that is a very defeated person!  Anyone who has the slightest bit of risk in their portfolio, 401(k) or not is Read more »