Louise, age 51, quit her job and received a $70,000 distribution from her employer-sponsored qualified retirement plan. She immediately contributed $50,000 to a rollover IRA and used the remaining $20,000 to purchase a car. Compute the tax cost (and premature withdrawal penalty, if applicable) of the distribution if Louise has a 32% marginal tax rate on ordinary income.

Question

Quizplus · Accepted Answer

The $50,000 contribution to a rollover IRA is not subject to any tax or penalty since it is a direct rollover from her employer-sponsored retirement plan to an IRA. However, the $20,000 used to purchase a car is considered a distribution subject to taxation and potential penalties.

The tax cost of the distribution is computed as follows:
$20,000 distribution x 0.32 = $6,400
There is no mention of any exception to the early withdrawal penalty, so we assume it applies. The premature withdrawal penalty is 10% of the distribution amount, or $2,000.

Therefore, the total cost to Louise is $6,400 in taxes plus $2,000 in penalties, for a total of $8,400. The correct answer is B.

Louise, Age 51, Quit Her Job and Received a $70,000