A Special Tax Notice Regarding Plan Payments written by the IRS provides detailed information on the tax treatment of distributions. Refer to the 401(k) Notice for payments from the 401(k) Plan or the 457 Notice for payments from the 457 Plan.
How will my benefits be taxed?
Payments you receive from either deferred compensation plan will be reported to you and to the IRS. They must be reported as income in the year(s) you receive them. Payments from the 457 plan are taxed in the same manner as regular wages and payments from the 401(k) plan are taxed as pension payments. For each year you receive a payment, the administrator or your annuity provider will mail your 1099-R form to you by January 31 of the next year.
Depending on when and how you withdraw funds from the 401(k) plan, one of the following special tax rules may apply:
1) Early Distribution Tax Penalty - Federal law requires a 10% tax penalty on 401(k) withdrawals made before age 59 1/2 except in the following circumstances:
- Distributions made after the participant's death,
- Distributions made after the participant's disability,
- Distributions which are part of a series of substantially equal periodic payments for the participant's life,
- Distributions made due to the participant's separation from service after age 55,
- Distributions which are used to pay medical expenses which would qualify for tax deduction, or
- Distributions which are rolled over to another eligible plan or IRA.
Determination and payment of the early distribution tax penalty is the responsibility of the individual. Refer to IRS Form 5329 for information.
2) Ten Year Forward Income Averaging - If you were born before January 1, 1936, you may be eligible to use ten year averaging if you take a lump sum distribution from the 401(k) plan. Forward income averaging tax treatment lets you figure your income tax as if you received the money over ten years instead of one year. Since it is also figured separately from tax on any other income, it can result in considerable tax savings. In order to take advantage of forward averaging, you must have been a participant in the 401(k) plan for five years or longer. Refer to IRS publication 575 Pension and Annuity Income and IRS Form 4972 for information.
You can continue to receive the best tax advantages from the program through careful planning before you select the time and method that benefits will be paid to you. You may want to consult a tax advisor before you make your selection. The tax rules explained in this booklet are subject to revision by Congress, so you should obtain current information before you choose a payment method.
How will withholding on my benefit payments be determined?
Withholding taxes will normally be applied to payments you receive. When you apply for benefits, you will have the opportunity to complete a Withholding Certificate on your distribution request form. You may file a new Withholding Certificate for either plan at any time.
On lump sum distributions from either plan and any other distributions that would be eligible for rollover, federal regulations require a flat 20% withholding. For annuity payments, periodic payments for ten years or longer, or minimum distribution payments, withholding will be based on your marital status and the number of withholding allowances claimed. If you do not file a Withholding Certificate, withholding taxes will normally be calculated as if you were married with three dependents. The total amount withheld will be reported to you and to IRS on your annual 1099-R form.