In the Summer 2011 edition of Retirement News for Employees, the Internal Revenue Service (“IRS”) provides guidance on whether the 20% federal income tax withholding requirement applies to a distribution from a qualified retirement plan. The IRS said the following.
The plan administrator should only withhold 20% for federal income tax from eligible rollover distributions. A plan administrator doesn’t have to apply withholding if expected distributions to an individual are less than $200 for the year. The 20% withholding generally only applies to any previously untaxed
amount of the eligible rollover distribution (not to any already taxed amount – cost). However, no withholding is required if the plan directly rolls over (in a trustee-to-trustee transfer) the amount to another qualified retirement plan or IRA.
Distributions that are not eligible rollover distributions are subject to different withholding rates depending on whether they are periodic or nonperiodic payments. Periodic payments are made at regular intervals for more than 1 year (for example, an annuity). Generally, the plan administrator must withhold at the rate for a married individual with 3 withholding exemptions. However, the plan administrator must notify the recipient of his or her right to elect no withholding, or elect to have a different amount withheld, by filing Form W-4P with the plan administrator. Either election may be changed at any time. The plan administrator must withhold 10% from any required minimum distributions and 20% from any excess amount distributed that is an eligible rollover distribution.
Nonperiodic payments are distributions that usually aren’t made at regular intervals and are not eligible rollover distributions. Examples include distributions of: (1) excess annual additions, (2) excess contributions and excess aggregate contributions from most plans if made within 2 ½ months after the end of the plan year, (3) hardship distributions and (4) loans treated as distributions. The plan administrator must withhold 10% from these payments. However, the recipient may elect no withholding or have a different amount withheld by filing a Form W-4P with the plan administrator.
The IRS also discusses withholding in special situations. The IRS points out that a plan administrator may be subject to penalties for failing to properly withhold, deposit or report taxes, and to electronically deposit withheld taxes.