Arizona Life and Health Practice Exam

What is the income tax withholding requirement for an individual who personally receives eligible rollover funds from a profit-sharing plan?

1. No withholding required

2. 10% is withheld for income taxes

3. 15% is withheld for income taxes

4. 20% is withheld for income taxes

The correct answer is: 20% is withheld for income taxes

When an individual personally receives eligible rollover funds from a profit-sharing plan, the income tax withholding requirement is that 20% is withheld for income taxes. This rule applies specifically to distributions that are not rolled over directly into another retirement account. When an individual takes the distribution in hand rather than undergoing a direct rollover, the IRS mandates a withholding of 20% from the taxable amount. This withholding serves as a prepayment of the individual's potential income tax liability, which is why it is specified at this rate for eligible rollover distributions. It's important to note that this requirement is designed to ensure that individuals do not fully cash out their retirement savings without considering the tax implications, encouraging them to roll over their funds to maintain tax-favorable treatment. Understanding this withholding requirement helps individuals make informed decisions about their retirement funds and tax obligations.