How will my 401(k) withdrawal and resulting adjusted annual income be taxed?
I am 70 years old and fully retired - I have annual income of $70,000, made up of Social Security payments totaling $31,000 and a yearly pension of $39,000 provided by a former employer. According to the 2017 tax rate charts, that would place me in the 25% tax bracket. I am interested in taking a $50,000 withdrawal from my 401(k) plan. Typically firms administering the 401(k) plans would hold 10% of the requested withdrawal for federal tax purposes. However, after this withdrawal would my total taxable income become $120,000 ($70K income plus $50K withdrawal), moving me into the 28% tax bracket? Also, because my plan administrator is holding 10% of the withdrawal for tax purposes, how does that tax factor into the income tax owed on the total amount of $120,000 (if the $50K will be taxed as ordinary income)?
Congratulations on your retirement and even more so that you have a pension, social security and 401(k).
Your analysis is on the right track, we just need to do some adjusting to get the numbers in line. The adjustments are based on you are a single filer for tax purposes and the pension is fully taxable. Regarding Social Security benefits, no one pays taxes on more than 85% of their Social Security benefits. Referencing SSA.gov, it appears your Social Security income is taxable up to 85%, making the amount included in gross income = $26,350.
The income tax brackets are based on taxable income. Perhaps try a tax calculator such as: http://www.calcxml.com/calculators/federal-income-tax-calculator?skn=#results. Using the pension of $39,000 and social security of $26,350, single filer and standard deductions, your taxable income is just under $55,000, with taxes due of about $9,500. This is in the 25% marginal tax bracket.
Now that we know your current taxable income, any additional taxable income up to $91,150 will be taxed at the 25% rate. To avoid escalation into the higher rate, 28%, one could take an additional $36,000 of income.
Using the Social Security exclusion and standard deductions resulted in the taxable income to be $55,000, not the $70,000 as originally expected. If you were to take all $50,000 from your 401(k), only $15,000 would be taxed at the next margin rate (28%). The additional 3% on $15,000 is $450.
When filing your income taxes, the taxes withheld by your 401(k) administrator will be shown as taxes already paid. This will result in taxes due being less that the total tax. If your 401(k) withdrawal is $50,000; the plan administrator withheld $5,000 and forwarded to the IRS. The tax calculator shows with your pension, taxable Social Security and $50,000 withdrawal from your 401(k), tax liability to be $22,368. The plan administrator withholding $5,000 or 10% would make the tax needing to be paid be $17,368.
Hope this helps in your planning!
You appear to be a single filer based on your reading of the tax table. The 2017 tax tables show that on the first $91,900 the effective (not the marginal) tax rate is just over 20% or $18,713.75. If you take the withdrawal from your 401(k) you will then pay 28% of the amount of your income that is above $91,900.
However, if your social security and pension income is gross, not net after tax, you have a personal deduction that will reduce the tax that you owe.
The 10% that is withheld for the 401(k) distribution is simply the pre-payment of the tax that you owe on the distribution. It does not reduce the taxable income you must report.
The $50k would count as income to you thus increasing your annual income to $120k. The 10% withholding would go toward your taxes paid and you would simply owe the difference. Normally, 401ks are required to withhold 20% on any distributions which is why I was going to recommend looking into rolling your 401k assets into an IRA Rollover.
Costs are less in an IRA and you can control whatever amount of withholding you want. You could set it at 10%, 15%, 20%, or even zero. You obviously would be responsible for any shortfall. But most 401k plan expenses are borne at least partially, if not fully, by the plan particpants, not the company. There may also be relationships that you are not aware of. So an IRA would give you almost unlimited investment choices and be cheaper. It is usually the best choice upon termination of service.
Hope this helps and best of luck, Dan Stewart CFA®
There are a number of considerations in your question that may require more detail to answer specifically:
- Some portion of your Social Security income benefit may not be taxable
Refer to this IRS website for some insight relevant to you
- Some portion of your pension payment may not be taxable
Again, the IRS has a site that can help determine your situation
- Are there factors in your tax return that lower your Adjusted Gross Income?
Setting aside for the moment the considerations above and looking just at your question as asked: the distribution from your 401(k) will generally be treated as an addition to your ordinary income for the year and will be taxed at your marginal rate (only the dollars earned in the marginal income bracket are taxed at that highest marginal rate) and the 10% amount withheld would apply to your eventual overall tax liability for the year. When your tax return for the year is calculated, any withholding or estimated tax payments made over the course of the year are compared to the total liability to determine your net tax owed or refund due.
Consulting with a qualified tax professional is always a good idea, particularly if you believe your case involves more complicated factors.
The simplest solution is to take all of your 401K and roll it into an IRA.
Invest it as you see fit -- if I were managing it I'd probably put most (but not all) of it into bonds and preferred stocks -- and take the mandatory minimums starting in the year you turn 70-1/2 (is that this year?). You can always take more than the minimum if you choose. Your custodian can take withholding but you can elect to waive it (consult your CPA as to how or if to make estimated-tax payments.)