Hello. My company was recently sold, and now employees have the choice between receiving a lump sum distribution from ESOP, or rolling over into 401K. I have chosen to take the payment and have been advised that they will withhold 20% for federal taxes. I was also told that there will be a 10% early withdrawal penalty, which I will be responsible for paying when I file my taxes the following year. However, I am not sure how state taxes, and FICA are handled. Will I also be responsible for these? Plus, it is my understanding that this distribution will be added to my income and taxed as such, is this true? If that is the caase, would it be possible to responsible for more than the 20% federal, because I know I would be in a higher tax bracket. This is all really confusing...any help would be GREATLY appreciated!!! Thank you for your time.

As part of the plan termination process, at some point you will receive a distribution election package. Generally, included in that pacakge will be:

A. Distribution Election Form

B. Special Tax Notice

The Special Tax Notice will answer most of your questions.

You will also be advised to speak with a professional tax advisor. I would encourage you to do so.


In most cases:

You will be given an option to withhold more than the 20% (federal income tax) at your election.

If you live in a state that has anincome tax, you will likely be given an election to withhold a percentage for state income tax.

Generally, the distribution you receive should you not elect a rollover, will be taxed as ordinary income.

You are correct that the total distribution amount (what you receive plus what is withheld) will be taxable income to you. It will add to your other ordinary income for the year.

As a result, depending on the tax bracket you end up in, your taxes on the distribution could be more than the 20% that the plan is required by law to withhold. And if you are under age 59-1/2, you will also add the 10% penalty to your federal tax bill (that's 10% of the total distribution amount).

If your state has an income tax, the added income will increase your state income tax. Some states also have an early withdrawal penalty.

In most cases, the taxes take a huge bite. If this is looking like too big a bite, you might reconsider rolling over to a 401(k). In that case, you are not liable for the taxes until you take the money out of the 401(k). There may be different rules for taking distributions from the 401(k), but the big advantage of the rollover is in postponing the taxes.

If you have the distribution paid to you, you have 60 days to rollover all or a portion of the money you receive into an IRA. The amount you rollover in 60 days is not considered as taxable income this year, and the 10% penalty will not apply to that rollover amount. You actually have the right to rollover the total distribution amount within the 60 day limit, but in that case you have to come up with the withheld amount from other sources, like from your other savings.

The special tax notice you receive from the ESOP will cover these topics and others in more detail. These notices are usually small print and cover topics that you are not interested in, but I recommend reading it carefully. As A Shot in the Dark said, the Notice will answer most of your questions.

Thank you both for your help!