401k Withdraw Confusion..

[AmandaRaeJean4]

I am very confused with the Covid-19 Care withdraw portion within the 401k. I think this is what I grasp... correct me if I am wrong please. 

Withdraw "X". No penalties , aka no 10% early withdraw fee. You only pay federal withholding fee from what I gather. The only other potential fee you may end up paying is IF, IF you end up being pushed into a higher tax bracket when you claim this on your income for next year. If that part is correct, the tax brackets are fairly large if I am not mistaken and would need to be massive for it to actually matter? Can anyone give input in plain english that Id be able to understand. Please and thank you. 

[AnnetteB6]

Here is some information about taking a distribution from your 401k:

Penalty Waived for Early Retirement Withdrawal

If you need to take money out of your retirement plan ASAP, keep in mind that the 10 percent early withdrawal penalty may be waived on up to $100K of retirement funds withdrawn if you are a qualified individual impacted by Coronavirus.  You are a qualified individual if:

• You, your spouse, or dependent are diagnosed with Coronavirus 
• You experience adverse financial consequences as a result of being quarantined, furloughed, or laid off
• You had hours reduced due to Coronavirus
• You are unable to work due to your child care closing or reducing hours

Additionally, income attributable to such distributions would be subject to tax over three years, and you may recontribute the funds to an eligible retirement plan within three years without regard to that year’s cap on contributions.

So, you are correct that the 10% early distribution penalty will be waived if you are a qualified individual impacted by Coronavirus.  However, any amount that is distributed from the 401k will be added to your income and taxed as ordinary income.  The Federal taxes withheld from the distribution should help to cover any additional taxes that you may owe when the income from the 401k distribution is added to your other income.  But, you are not guaranteed that the withholding will be all that you will need to pay when the distribution is added to your other income.  

Also, you can spread out the taxes over the course of three years according to the information above instead of having it all taxed in a single year.  Until we see the tax return information for 2020, there are no additional details for how this will actually be done.  

@AmandaRaeJean4

[dmertz]

For qualified coronavirus-related distributions, the CARES Act also waives the 20% mandatory withholding normally required on distributions from qualified retirement plans like a 401(k) that are otherwise subject to 20% mandatory withholding.  Of course if you decline the withholding, you'll have a larger balance due when you file your 2020 tax return which might result in tax underpayment penalties.

[AmandaRaeJean4]

I see. Say your only taking out a very small portion of like $3400, and the withholding is roughly $360 ish, give or take. So you end up only receiving roughly $3000, on your 2020 taxes, do you think you would end up owning a bunch more?

[dmertz]

Assuming that your 401(k) has no basis in nondeductible contributions, which is usually the case, if you take out $3,400, the entire $3,400 is includible in your taxable income no matter how much of that $3,400 is withheld for taxes.  The amount withheld for taxes has no effect on the income tax consequences, it only affects whether or not you might be subject to an underpayment penalty.

Whether or not 10% withholding would be sufficient to cover the additional income tax liability resulting from the distribution depends on your marginal tax rate which is not determined until you take into account all income and deductions for the the year.