Heavy Price to Pay

[peredehuit]

I retired July 2020. We live comfortably on combined Social Security and two pensions.

In Aug 2021 I withdrew a large sum from my 401(k) to purchase a camper van. My wife is 3 years into an Alzheimer's diagnosis so we thought we should use some of those retirement funds while she can still enjoy and benefit.

In Nov 2021 we decided to move closer to family. We quickly sold our home at a good price but purchasing a replacement home in the new city was not going well--homes were $200K more expensive and selling FAST. We lost out on several homes to cash offers from other buyers, so decided we must make a cash offer to compete. In Dec 2021, I took a large 401(k) distribution to supplement the proceeds from our home sale and made a cash offer, which was accepted. We finalized the purchase in Jan 2022 and are comfortably settled in our home.

You probably have already guessed at my problem--those two large 401(k) distributions in 2021 bumped me up to a 35% Tax Rate on my 2021 tax return. Although I had withheld taxes for each of the distributions, I naively assumed a 22% rate. Now, TurboTax shows I under-withheld $35K in taxes. Ouch! I suspect I am just out of luck and will need a payment plan to recover. Any other suggestions?

[Vanessa A · Accepted solution]

Unfortunately, the only thing you can do is do a payment plan or pay in full.  There is no way to actually reduce the taxes you owe when it is caused by jumping tax rates. In order to do that, you would have to reduce your taxable income. The 401K is taxable, as are your pensions and your social security with your other income. 

You could potentially itemize your return, depending on your wife's medical expenses, this may help, but if your insurance covers most of it then that will not help and you would only be able to deduct expenses over 7.5% of your AGI.

You could also see if you qualify for a Offer In Compromise using the IRS tool which may allow you to reduce your tax debt. 

[peredehuit]

Thank you for a quick reply! I'll check out the Offer in Compromise.

[selffilling]

Hello,

If person who takes money from 401 K is disabled should they pay the same taxes as everybody else? 

[DoninGA]

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@selffilling wrote:

Hello,

If person who takes money from 401 K is disabled should they pay the same taxes as everybody else? 

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Yes.  There is not a different tax bracket for being disabled.

[VolvoGirl]

If you are under  59 1/2 you can avoid part of the 10% early withdrawal penalty for Medical expenses.  

Exceptions for Early Distributions from a Qualified Retirement Plan such as a 401(k) or 403(b) plan. See Pub 575 page 36 Additional Exceptions
https://www.irs.gov/pub/irs-pdf/p575.pdf

..Distributions upon the death or disability of the plan participant.
..You were age 55 or over in the year you retired or left your job. (50 for qualified public safety employees)
..You received the distribution as part of "substantially equal payments" over your lifetime.
..You paid for medical expenses exceeding 7.5% of your adjusted gross income.
..The distributions were required by a divorce decree or separation agreement ("qualified domestic relations court order"),

The questions about exceptions to the penalty do not come after entering the 1099-R. Rather, you will see that area after you have finished all the Deductions and Credits section.

[selffilling]

Thank you!

On 1099-R form 20% were withheld but after I entered the form in turbotax it increased taxes significantly. 

[selffilling]

thanks

[VolvoGirl]

The 20% is just an estimate for withholding.  The 1099R added to all your other income and may push you into a higher tax bracket.  And there is the 10% Early Withdrawal Penalty.  You can lose like 50% or more for federal and state taxes and penalties.  And by adding more income it can decrease some credits you were getting.  It can change many things on your return.