Legally Take a Pension Plan Withdrawal Without Paying a Penalty

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Legally take a pension

Got a tax question? Ask it at USTaxAid. Here’s a recent question I received at my website.

I have a few questions related to taking a distribution from a solo-401k. I’ve inquired about a loan, but was told it is not an option with this type of account. I want to pull some money out to be used for business expenses, medical premiums, and business investment.

A: The restriction on taking a loan out of a solo 401(K) must be a company restriction. Under tax law, you can take a loan of up to 50% of the account balance or $50,000, whichever is lower. You may want to shop around for a new custodian who will allow the loan.

Q: Is a business investment considered an exclusion from the penalty?

A: In this case, I’m assuming that you decided to not take a loan and instead do a withdrawal. You will pay tax on the withholding.

There are a number of ways that you can take a withdrawal and not pay a penalty.

Be over 59 ½

Use the money for medical expenses

Use the money for health insurance

Use the money for higher education

Use the money to buy a first home

Use the money because you (or a family member) have a disability

Use the money because you are going in the military

Use the money to set up an annuity

You would pay a penalty if you took a withdrawal (and not a loan) for small business business funding.

Another option might be the ROBS (roll-over business start-up) which allows you to roll a 401(k) to a C Corporation 401(k). With this you can fund a business. There is more paperwork. There are more costs to set it up. And, it means you have to operate through a C Corporation. But, it means you can use the money without paying tax or penalty. (Google ROBS and you’ll find out more information on the program)

Q: Can I contribute back to the solo-401k by the following tax year deadline, thus netting out the original withdrawal for a $0 impact on taxable income (assuming same $ amount on distribution now and contribution later)?

A: If you do a rollover to an IRA, you have 60 days to fund the rollover. So you could take the distribution for the rollover, invest the money for 59 days and then put it in the rollover IRA account

If you miss the deadline, it’s taxable and subject to the penalty

Q: Or if not ok to do that contribution into the same account as the distribution, can the taxable impact be offset by a contribution from my wifes business into her solo-401k, effectively netting to $0 impact on a combined basis for our taxable income as a married couple?”

A: Perhaps. You’ll pay the penalty regardless. But, at least theoretically, you may be able to offset the tax on the withdrawal by contributing the same amount.

So, let’s say you decide to take a withdrawal of $50,000. You will have a $5,000 penalty and the $50K adds to your taxable income. If you then later make a $50K contribution to a pension plan, you would net out the withdrawal income. You’ll still owe the penalty though.

One thing to watch, though, is the amount of pension you’re allowed to contribute. This is based on the salary you draw. If you do draw out $50K and then take a salary of something small, like $30K, you can’t make a big enough pension contribution to make the offset.

I would start with finding someone who will allow you to take a loan. If you can’t do that with current custodian, consider moving to someone who will.











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