It has come to our attention that there are numerous individuals that are cashing in their employer based retirement plans early.    In other cases, the employer plan was terminated and the funds were distributed to the employee.    Upon submission of the required paperwork to receive the funds, these individuals stated that the HR department told them that 20% of the funds must be held back and sent to the IRS to help cover their tax liability.

This apparently conflicts with a box on the form that states that an individual can choose not to have the taxes withheld.  Apparently, these individuals had anticipated receiving the full amount.  They are at odds with HR, pitted between what the organization may well deem its duty from a tax perspective and the fact that the individual anticipated receiving the full sum, taxes be damned.  However, upon further review, it turns out that the 20% is required to be withheld from the lump sum payment.  Therefore, the HR department acted correctly in this situation. 

So, if you receive any money from your employer based retirement plan, through voluntary or involuntary withdrawal, you will need to factor receiving 20% less than the distributed amount.  In addition, before withdrawing any money from a 401K without rolling it over, consider the tax ramifications of doing so.  You will need to pay tax on the amount that was distributed.  If the amount is substantial, it may increase the amount of tax due to IRS or reduce the amount of expected refund.  In addition, if you do not qualify for an exception, you will also be penalized 10% of the amount that was withdrawn.  This amount is in addition to the tax due. 

It is highly recommended that you put aside some of the money that you withdraw to cover any possible shortfall in your tax liability.  In many cases, individuals spend the money only to find later that their tax liability was more than they anticipated.  And they do not have the funds to pay by the due date of the return.  If this happens, you'll be forced to obtain an extension to pay or installment agreement with the Internal Revenue Service.  Keep in mind that under this option, interest and late payment penalty will be charged on the unpaid balance causing you to owe more in the long run.  Do not let this happen to you.