Question

After her husband died, Stacy (age 48) decided to take the $120,000 balance from his defined contribution pension plan in cash. If she did so, which of the following statements is CORRECT?

1. Stacy will not incur any taxes on the $120,000 cash withdrawal.
2. Stacy must pay ordinary income tax on the $120,000 withdrawal.
3. Stacy can roll over the $120,000 into her own IRA without any tax consequences.
4. Stacy is only subject to capital gains tax on the $120,000 withdrawal.

Answer 1

Stacy would have to pay ordinary income tax on the $120,000 cash withdrawal from a defined contribution pension plan, although she can also choose to roll it over into an IRA to defer taxes.

Step-by-step explanation:

After Stacy's husband passed away, she made the decision to withdraw the $120,000 from his defined contribution pension plan in cash. If she does so, the correct statement is that Stacy must pay ordinary income tax on the $120,000 withdrawal. Defined contribution plans, such as 401(k)s and 403(b)s are tax deferred, meaning that while contributions to these plans are made with pre-tax dollars, and investment growth is not taxed as it occurs, distributions or withdrawals are taxed at the individual's ordinary income tax rate. Rollover of the amount into an IRA is another option Stacy has to defer taxes, but taking the cash would not allow this deferral.