How to Pay 20% Withholding Tax on Your Early Distribution Solo 401(k) Plan
Pay 20% Withholding Tax on Early Distribution Solo 401(k) Plan. In this article, we explain how to do it.
You may currently have a Solo 401(k) (also known an Individual 401(k) and Self-Directed Solo 401(k)) Plan and you’re eligible to take out a distribution. However, you may be under the age of 59 1/2 (age of retirement). In this case, you will have to withhold 20% of the distribution amount.
Steps to Pay the 20% Withholding Tax
In the event that an eligible distribution is taken from a Solo 401K Plan and the Plan Administrator, not the financial institution, is responsible for reporting the distribution, this means the Plan Administrator must do the following:
- Complete the voucher on IRS Form 945 and pay the withholding tax due. The withholding tax should be paid electronically by EFTPS. Additionally, in some cases the tax can be paid by voucher using IRS Form 945.
- The Solo 401K Plan Administer must file the IRS Form 945 by January 31 of the following year. For example, for 2018, you need to file Form 945 by January 31, 2019. However, if your deposits are always on time and in full payment of the taxes for the year, you may file the return by February 10, 2018. Even if multiple distributions are taken, the IRS form 945 is only filed with the IRS once.
- The Solo 401(k) Plan Administrator will provide a copy of IRS Form 1099-R to the recipient by January 31 and exile it with the IRS by March 31. The determination of whether one is permitted to take a distribution from Solo 401(k) Plan should be discussed with the Plan Administrator. In addition, the determination of whether a distribution should be taken should be given careful consideration as their are potentially significant tax implications.
The Solo 401(k) Plan
Keep in mind that there may be more tax efficient methods for accessing the funds, such as, for example, a Solo 401k Plan loan. You can learn more about a Solo 401(k) plan in Solo 401(k) Plan – How Can I Benefit. You can also read Solo 401(k) Plan – How it Works. However, a Solo 401(k) Plan works like a traditional 401(k) plan – but for ONE employee. It was created by the IRS to specifically benefit small business owners and self-employed individuals.
If you’re a sole proprietor, small business owner, or independent contractor, this is an ideal plan. It is better than an SEP IRA due to the employee deferral exception. This allows Plan participants to make withdraws on their Solo 401(k) plan without triggering prohibited transactions. Like most self-directed plans, it allows you to branch our of traditional investments.
Avoiding the 20% Withholding Tax
Before you take an eligible distribution from a Solo 401(k) that is subject to the 20% withholding tax, first consider the alternatives. In general, a “triggering event” must be satisfied before a distribution can be taken from a 401(k) plan. Typically, a “triggering event” is any event that allows the Plan participant (you) to become eligible to make a withdrawal. Triggering events can include terminating employment with the employer that sponsors the plan, or even disability. Therefore, if you are over the age of 59 1/2 or you plan to leave your job, you are then eligible to roll the 401(k) funds into an IRA without tax or penalty. The advantage of taking a taxable distribution from an IRS versus a 401(k) plan is that distributions from an IRA are not subject to the 20% withholding tax.