Liquidated 401K from former employer, paid 25% in taxes to the brokerage company holding the account..HELP!!?

Question

Heres the deal, I am a financial advisor and a friend just called me for advice...but he is a little too late.

A company he was working at for over 13 years, closed it's doors and he was layed off. He has since found new employment and is in good shape financially.

4 Months ago he received his 401K statement and was upset that it keeps losing money. He was embarassed to call me for advice thinking he didn't want to waste my time (I certainly wish he had called me). He called the brokerage that held his 401K and told them he is sick of losing money that he would be better off having his money in the bank and asked to close his account.

The customer service rep. stated that he would have to pay 25% in taxes and asked if he wanted to pay it now (deduction of check amount) or when he files his taxes. Out of disgust he told them to take the money out and send him a check.

Upon receipt of check he deposited it in the bank (reg. taxable account) and put it in a 12month CD.

Answer 1

You are a Financial Advisor and don't understand this??  Go to www.401k.org.  The fact that he didn't understand the consequences of a premature withdrawal doesn't undo the damage.

Answer 2

He's out of luck on the rollover aspect.  There is no fixing it.  But he can still minimize the damage.  

Since the number is only 20k I think it's safe to say that he hasn't been maximizing his contributions for the last 13 years (or even 2 years).  In this case this fact gives us some room to maneuver.   So what he needs to do is after the 12 month CD matures, he should maximize his contributions into his new company's 401k.   Defer 100% of his income into this plan for however many months it takes to use up the money in the CD. If there is 20k in there and he makes 2k a month he should maximize for as long as his plan will let him (about 7 months).   He should live off the proceeds of the CD for that time.  When that 7 months ends up there should still be 5k left in the bank account that he will repeat the process the following year.  Then when he does his taxes for each year he'll get a nice little refund.  This is because he'll have lowered his taxable income yet still have a significant amount withheld.   Take any refund and put that either into the 401k or into an IRA.  After 2-3 years he'll still be out the penalty aspect of it but at least he'll recover the taxes and get his money back into a tax deferred account.    It'll take time and discipline but he can recover.

Answer 3

NO!  after 60 days you are out of luck,  Period!

lesson learned for any future friends/ clients

Answer 4

First, your friend has no choice, the 401k company has to withhold 20% by law.  Second, he has 60 days to rollover the money in the bank to an IRA.   If he deposits an extra 20% of his own money into the IRA, then the IRS will refund his 20% to him.  And no IRS 10% penalty will be assessed.  You really cannot be a licensed Financial Advisor and not know this information.  Good luck on getting licensed.

Answer 5

If it were within 60 days of the distribution date, he could cover the 20% withholding out of his own pocket and roll over the full amount to an IRA.  (You mentioned 25% withholding; are you in a state which requires 5% withholding?).  

He would then recover the tax over-payment when he files his taxes next year.  Note: the withheld money did not go to the brokerage, it went to the IRS.

Since you implied that 4 months have elapsed since the distribution, it is too late to do this.