Q: I am a foreign worker in the United States on an H-1 visa. I have made significant contributions to my employer's 401(k) plan. My employment contract will end in the next six months and I intend to return to my home country. There is very little likelihood that I will take another assignment in the United States.

TB: The 10 percent early withdrawal penalty will apply if you receive a lump-sum distribution, unless you are over age 55 when you leave your employer.

If you aren't over age 55, there are several things you can do to minimize the tax impact.

One is to wait to take the distribution during a year when you have no other income that will be subject to U.S. taxes. For example, assume your contract ends in November 2001. You should wait until 2002 to withdraw the 401(k) money. In that case, the 10 percent penalty will still apply, but your income tax will be at a lower rate than if you withdrew the money during 2001. The reason is that if you took the money in 2001, you would be required to add the withdrawal to the income you earned for 2001 prior to leaving your employer.

Here's an example: suppose you earned $50,000 in 2001 and had $50,000 saved in your 401(k), which you withdrew. The 401(k) withdrawal would be added to your 2001 taxable income, for a total annual income of $100,000, pushing you into the 31 percent tax bracket. If you waited until 2002 to take the withdrawal, your earnings would be taxed at the 28 percent rate in 2001 and your 401(k) withdrawal would be taxed at the 28 percent rate in 2002 (provided you didn't have any other income in 2002 that would be taxable in the United States).

You can also avoid the early distribution penalty tax by waiting to withdraw money from the 401(k) until you turn 59ý.

Another way to avoid the penalty, if your plan allows it, is by receiving distributions over a period of years using a substantially equal periodic payment (SEPP) method that qualifies under Section 72(t) of the Internal Revenue Code. The catch is that most 401(k) plans don't permit these types of distributions; they only permit lump-sum distributions.

There is a way around this restriction, though. You can roll the 401(k) money into an IRA and begin taking SEPPs from the IRA.

Q: I'm 54. My employer just filed for bankruptcy under Chapter 11 and my job went away. I have money saved in 401(k) plans from three employers. I'm looking seriously at retirement. What is the maximum I can withdraw (in substantially equal payments) and pay the minimum in taxes?

TB: I recommend you consolidate the money from your three 401(k)s by rolling them into a single IRA to simplify things. You won't be able to withdraw the money from the IRA before turning 59ý without incurring a 10 percent early withdrawal penalty. But, there is a solution to this problem and I see from your letter that you are on the path to figuring it out.

I noticed that you are somewhat familiar with what are known as substantially equal periodic payments (SEPP). SEPP are one of the exclusions to the IRA early withdrawal penalty permitted under Section 72(t) of the Internal Revenue Code. If you take withdrawals using SEPP you will avoid the penalty. If you use this strategy you must take payments for at least five years or until you reach age 59ý, whichever is longer.

You will get the largest maximum withdrawal with the least tax by determining the amount you withdraw each year based on your life expectancy rather than a joint life expectancy. You will have flexibility to adjust the amount you are withdrawing after the five-year-or-59ý period expires without having to worry about the penalty. You will, of course, have to pay regular income tax on the amount you withdraw each year. The organization where you establish the IRA should be able to help you determine what amount to withdraw annually.

I'd like to clarify for your benefit and others that the age 55 rule that you referred to applies to 401(k) plans and not IRAs. Also, it only applies if you are already 55 when you leave your job.

Q: In error, my former employer issued shares of company stock in my name when I requested a 100 percent cash rollover to my current employer's 401(k) plan. The current market value of the distribution is $40,000. The basis is $33,000.

TB: Distributions from retirement plans usually aren't reported to the IRS until after the year ends. If the distribution hasn't been reported, you should be able to return the stock to the plan and have your former employer complete the transfer to your new employer's plan as you requested.