closing out 401k due to being disabled

[Guest sailfish2]

My wife has a 401k that she would like to close out. We have been told there is a 20% tax and a 10% early withdraw fee that we have to pay upfront(by the company managing the plan). She became totally disabled while working for a company about 10 years ago. Since then the company was sold(the local office shut down) and we have no idea how to get in touch with them.

A tax lawyer(free consultation during tax return season) told my wife it should be possible to get the the 10% penalty waived since she is disabled. The administering 401k people say she needs some kind of coding information from her old company for this to happen. The rep tells her he does not have a phone number so he can not get the info. However, to close out the account it would seem his company must have a way to contact them.

Should documentation from Social Security stating she is disabled be enough for the 401k company?

Is there any way to reduce the 20% tax withdrawal?

Any help will be greatly appreciated.....

[masteff]

First, it's not a 20% tax... it's 20% withholding for taxes. The amount of tax you owe will be based on your actual taxable income reported on your annual form 1040. The withholding cannot be avoided because the money is rollover-eligible. Ask the 401(k) company to send you a copy of their "Special Tax Notice" which will explain further about withholding and rollovers.

Second, if the distribution is not coded using the disability code, you can still file form 5329 which allows you to indicate that your wife is not subject to the 10% penalty due to total and permanent disability. Form 5329 is filed with your annual form 1040. If the IRS later questions it, the paperwork showing her total disability under Social Security should be sufficient.

[david rigby]

...

Third, consider having the plan make a distribution (a "closeout") in the form of a direct rollover to an IRA. See IRS Publication 575:

http://www.irs.gov/pub/irs-pdf/p575.pdf

[Guest sailfish2]

Thanks. To ensure I understand ......

1st - no problem, I understand

2nd - assuming no communication with the company can be had, they would asses the extra 10%(because they cant enter the proper distribution code) but we could recoup the money at tax time by filing the form 5329.

3rd - roll it into and IRA and then close that out. I assume this means that the IRA people would receive paperwork from us showing the total disability and not withhold the extra 10% and their paperwork for the next tax season would show the proper code so the IRS would understand?

Assuming I have the above correct, my only other question is are there fees associated with the rollover to the IRA that we would have to pay?

[masteff]

2nd - assuming no communication with the company can be had, they would asses the extra 10%(because they cant enter the proper distribution code) but we could recoup the money at tax time by filing the form 5329.

Not quite... the 10% is not "assessed" at the time of distribution. It's an extra tax paid on your form 1040. Only the 20% federal withholding (and possibly state w/h depending on your state's rules) would be taken out of the distribution. So by following the instructions of form 5329, you can avoid having to pay that extra 10% on your 1040.

And if you truly need the money in the next year or so for living or medical expenses, then I'd skip the step of moving it to an IRA. It would gain you almost nothing. But... if you don't need all the money right now, perhaps just a little of it each year, then the IRA would make great sense.

Lastly, you are probably in a tax bracket that is higher than 20%. Therefore, it would be to your advantage to have them withhold MORE than 20%. Otherwise, you're going to have a huge tax bill next April 15th and possibly not have the resources to cover it. By having enough withheld now, you avoid causing financial distress for yourself next spring. Your tax advisor can tell you what tax bracket you are likely in.

[Guest sailfish2]

I understand, thanks!!