SEP IRA

Question: I want to make an early withdrawal from my SEP-IRA. What can I expect in penalties & taxes?

I spoke to my financial advisor about withdrawing money early from my SEP, but I’m confused. I assumed that if I wanted to withdraw $12,000-$13,000, then I would get that amount “cash-in-hand”. I would then have to pay the 10% withdrawal penalty and income tax (I’d get Form 1099-R) next year during tax time.

However, my advisor is telling me in order to get $12,800 “cash-in-hand”, I’d have to take out $16,000. He said 20% (10% for the penalty and 10% for taxes) has to be taken out of $16,000 in order to get $12,800. I don’t understand – I thought the penalty and taxes were assessed when I file my taxes, not when I withdraw the money. Help!

Answer: The law requires the custodian to withhold 20% for taxes. This is exactly like the taxes withheld from your paycheck by your employer. In most cases even that is NOT enough if you are taking an early distribution.

The distribution is taxed as ordinary income. If you are under age 59 1/2 there is a 10% penalty on top of the tax in most cases. (There are some exceptions such as for medical expenses or to purchase a first home, etc.) If you are in a 15% tax bracket, the total will be 25% with the penalty so the 20% withheld would not be enough. And if you were in a 25% tax bracket, you’d be short by 15% at filing time and would need to make an estimated payment of that amount immediately on that large of a distribution to avoid any chance of penalties and interest for underpayment of tax when you do file. That means you’d need to pull $20k to have $13k net of taxes.

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