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Electing Out of Federal Tax Withholding

SITUATION: We have an employee who has requested a hardship distribution from her 401(k) account and does not want to have any federal income tax withheld.

QUESTION: Can employees choose to elect out of withholding on withdrawals such as hardship distributions?

ANSWER: Generally, any employee who receives a distribution that is not an eligible rollover distribution may choose not to have federal income tax withheld. A hardship withdrawal would be an example of a distribution not eligible for rollover. The right to elect out of withholding applies whether the distribution is periodic or nonperiodic.

DISCUSSION: Plan administrators must inform employees of their right to elect out of withholding. If an employee chooses not to have withholding, that choice will remain in effect until the employee notifies his or her employer of a change.

Generally, any time the participant clearly indicates his or her election, it must be given effect. However, if the payment is periodic, the plan administrator may require the employee to make the election up to 30 days before the first payment is due. If the distribution is nonperiodic, such as a hardship withdrawal, the plan administrator must abide by any election made as of the time of distribution.

The plan administrator also must notify employees that any prior election is applicable until revoked. In addition, the notification must inform employees how to revoke a previous election and give notice that if the amount of tax withheld is less than the employee’s estimated tax payment requirements, penalties may apply.

For nonperiodic withdrawals, the plan administrator must notify employees of their right to elect out of withholding no sooner than six months before the distribution and not later than the time an application for benefits is provided.

Employees receiving periodic distributions, such as required minimum distributions, need to be informed of their right to elect out of withholding no earlier than six months before the first payment and no later than the date of the first payment. Subsequently, plan administrators must inform employees of the right to make and revoke the election at least once each calendar year.

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