Question

Samantha, who is 54 years old, has been a participant in the LDR 401(k) plan for many years. She wants to take a distribution to pay for her niece to go to college, which is permitted by the plan. The plan permits pre-tax contributions and after-tax contributions. The plan has not been amended to offer a Roth account. Samantha contributed $100,000 in pre-tax salary deferrals and $50,000 in after-tax contributions. The total value of her 401(k) plan is $250,000.

If she takes a distribution of $20,000, then which of the following is correct? Explain each statement with justification.

a.The entire distribution is ordinary income, but not subject to the early withdrawal penalty.

b.$4,000 will be treated as a return of basis and she will have an early withdrawal penalty of $1,600.

c.$13,333 of the distribution is treated as ordinary income and she will have a penalty of $2,000.

d.$13,333 of the distribution is treated as ordinary income and she will have a penalty of $1,333.

Answer 1

• B)$4,000 will be treated as a return of basis and she will have an early withdrawal penalty of $1,600.

Since Samantha is not ye 59.5 years old, she will pay a 10% withdrawal penalty. The amount considered as a withdrawal for tax purposes = $20,000 - $4,000 return of basis = $16,000 ⇒ so the penalty will be $1,600.

The LDR 401k plan has a profit sharing component which allows Samantha to withdraw 20% as return of basis ($4,000), while the remaining 80% will be considered interest income ($16,000) and will be taxed as such.

Step-by-step explanation:

the other statements are wrong because:

a.The entire distribution is ordinary income, but not subject to the early withdrawal penalty. ⇒ Early withdrawals of 401k plans are always subject to penalties.

c.$13,333 of the distribution is treated as ordinary income and she will have a penalty of $2,000. ⇒ The penalty is calculated on the amount that is considered withdrawal of interest income.

d.$13,333 of the distribution is treated as ordinary income and she will have a penalty of $1,333. ⇒ Samantha's plan allows her to withdraw only 20% as return of basis, not 33.3%.