Dear Ryan:
This was a difficult question to research. I have identified a number
of sources of material which I hope you will find useful. I had to
make some estimates because the data simply is not available to
calculate the median amount paid in penalty taxes and additional
income taxes precisely. However, the data I was able to find suggests
that the average is probably not far off from the median because most
balances that are cashed out are of relatively low value, very few
high-value balances exist, and very few of the high-value balances are
cashed out.
My findings: Approximately 42% of workers take their retirement plan
distributions in cash. The maximum tax rate charged on the cashed out
balance is 45%. A reasonable estimate of the amount paid in penalties
per person is $713, which represents a typical cashed out balance of
$7,130. The vast majority of people are in the 25% tax bracket, so
the total amount paid per person is approximately 35% of the cashed
out balance or $2495.50.
Sincerely,
Wonko
"Hewitt?s analysis of 160,000 employees who took 401(k) plan
distributions in 2002 found that nearly half -- 42 percent -- of
workers cashed out of their 401(k) plans when they changed jobs."
"Hewitt Data Shows U.S. Employees Cash Out of 401(k) Plans When
Changing Jobs" Hewitt Associates, November 5, 2003
http://was4.hewitt.com/hewitt/resource/newsroom/pressrel/2003/11-05-03.htm
This press release is a great resource with a variety of interesting
statistics on employees' withdrawal behavior.
The additional penalty for early withdrawal is 10%.
"17.1 Individual Retirement Arrangements (IRAs): Distributions, Early
Withdrawals, 10% Additional Tax" Internal Revenue Service
http://www.irs.gov/faqs/faq17-1.html
The maximum tax bracket is currently 35%.
"Revised 2003 Tax Rate Schedules" Internal Revenue Service
http://www.irs.gov/formspubs/article/0,,id=109877,00.html
Therefore, the maximum tax penalty for early withdrawal is 45% of the
amount withdrawn.
"Penalty Tax on Qualified Retirement Plans (line 55, Form 1040)
If taxpayers withdrew any funds from an Individual Retirement
Arrangement or qualified retirement plan before they were either age
59-1/2 or disabled, they were subject to a penalty tax equal to 10
percent of the premature distribution. Any taxpayer who failed to
withdraw the minimum required distribution after reaching age 70-1/2
had to pay a 50 percent excise tax on the excess accumulation.
Contributions to the IRA?s in excess of the legal limitation for the
year (the lesser of $2,000, $4,000 if married filing jointly, or the
taxpayer?s compensation for the year) were subject
to an excise tax equal to 6 percent of the excess contribution."
"Explanation of Terms" Internal Revenue Service
http://www.irs.gov/taxstats/article/0,,id=96586,00.html
4,571,187 tax returns in 2001 paid $3,259,975,000 in penalty taxes on
qualified retirement plans. Therefore, the average tax return paying
a penalty paid $713. This would reflect a cashed out of balance of
$7,131 if we ignore the effects of the excise taxes. I think this is
reasonable because I believe that the excise tax situations are
relatively rare compared to the penalties for nonqualified
withdrawals. Also, as the sources below indicate, most retirement
plan balances are not very large and it is the small ones that are
cashed out most frequently.
"Table A: Individual Income Tax Returns: Selected Income and Tax Items
for Selected Years, 1997-2001, in Current and Constant 1990 Dollars"
Internal Revenue Service http://www.irs.gov/pub/irs-soi/01intba.xls
The average 401(k) participant earns about $51,000 per year, which
would put them in the 25% tax bracket. "The median balance (as a
percentage of pay) of participants is 40%.... Low salary participants
have even a considerably lower ratio of balance as a percent of pay."
This figure suggests that a reasonable typical balance for the average
participant is $20,400.
"Hewitt Research Shows U.S. Employees Not Interacting with 401(k) Plan
for Optimal Benefit" Hewitt Associates, July 8, 2002
Given that the majority of the balances that are cashed out are $5,000
or less, very few large balances exist, and very few large balances
are cashed out, the average calculated above is a reasonable
approximation of the median.
"401(k) Distribution Rollovers by Balance" Hewitt Associates November
5, 2003 http://was4.hewitt.com/hewitt/resource/newsroom/pressrel/2003/401(k)_distribution_rollovers.pdf |
