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Question: My client received a distribution from her pension plan, and the pension plan administrator withheld 10%, instead of the mandatory 20%, for taxes. Does my client need to do anything to correct the under-withholding?
The obligation to withhold 20% of a taxable pension distribution for taxes is imposed on the pension plan administrator. The rules require the administrator to withhold 20% of any distribution made to the plan participant for federal income tax purposes.
The withholding is a way for the IRS to hold on to part of the tax the client may owe due to the distribution.
The fact that 20% of a distribution is held back to pay for taxes can create problems for the taxpayer, especially if the client later decides to roll over the distribution to an IRA or other qualified plan within 60 days of receipt, which is permitted by law. If the taxpayer fails to roll over the 20% that was withheld to pay taxes, the withheld amount is considered a distribution and the amount is subject to income taxes—and also possibly the premature distribution 10% penalty tax.
If the administrator withheld 10% instead of 20%, it’s not the participant’s problem to solve. The client will reconcile the tax results associated with taking a distribution with the amount withheld on the client’s tax return for the year of distribution. The client may end up owing more in taxes when the return is filed because a smaller amount was prepaid by the withholding.
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