Your One Stop Resource for Saving Money.
Information on Tax Obligation Due to 401K Withdrawal - The Bills.com Blog
Bills.com Blog > Other Questions > Tax Obligation Due to 401K Withdrawal
Information on Tax Obligation Due to 401K Withdrawal
Monday, Oct 27, 2008
Question: Bill, I have a question for you. I bought a condominium a year and a half ago. I took the downpayment from my pension plan from work . At that time I was told that I could take that money without any penalty if it was to buy my first home (as it really was), then now the IRS sent me a note that I have to pay taxes for that money. I'm doing it through a payment plan. Some people had told me that it is a mistake because I don't owe money to the IRS for taking that money for that purpose and other people have told me yes. I'm very confused about that. Can you clarify this for me, please? Thank you.
Answer: The taxes you are required to pay on this withdrawal depends on the type of retirement plan your company has established. Most companies now offer 401(k) retirement savings accounts for their employees, though some companies still use private retirement plans or fixed-benefit pension plans. From the description in your question, I believe that the account to which you refer is a 401(k) plan. Money deposited into a 401(k) is paid into the account on a pre-tax basis; basically, your employer takes money from your pre-tax earnings and deposits the money into the 401(k) account on your behalf, along with any contribution made by your employer. Therefore, you have not paid income taxes on the money in your 401(k) account; because of this, if you decide to withdraw any money from your 401(k) account, you are required to pay taxes on the money at your regular income tax rate. For this reason, 401(k) accounts are referred
to as “tax deferred” savings accounts. To learn more about 401(k) plans, I encourage you to visit http://www.401k.org/.
Generally speaking, if an account holder wishes to make an early withdrawal from his 401(k) account, he will be charged a 10% penalty tax in addition to the regular income taxes he will be required to pay on the money. Taking money out of a 401(k) account can thus result in a tax obligation of 35% or more of the total amount withdrawn; for example, if you withdrew $10,000 from your 401(k), you could be charged $3,500 or more in taxes and penalties. The penalties promulgated by the IRS are designed to discourage Americans from making premature withdrawals from their 401(k) accounts, since 401(k)s are designed to help workers save for retirement, not as a means of saving for other purposes.
You will almost always be required to pay your income taxes on any withdrawal from your 401(k) account, regardless of the reason for the withdrawal. These taxes are due because you have not yet paid taxes on the money deposited in your 401(k) account. While you generally cannot avoid regular income taxes on the 401(k) withdrawal, you can, under certain circumstances, be excused from 10% additional tax penalty charged
Generally speaking, if an account holder wishes to make an early withdrawal from his 401(k) account, he will be charged a 10% penalty tax in addition to the regular income taxes he will be required to pay on the money. Taking money out of a 401(k) account can thus result in a tax obligation of 35% or more of the total amount withdrawn; for example, if you withdrew $10,000 from your 401(k), you could be charged $3,500 or more in taxes and penalties. The penalties promulgated by the IRS are designed to discourage Americans from making premature withdrawals from their 401(k) accounts, since 401(k)s are designed to help workers save for retirement, not as a means of saving for other purposes.
You will almost always be required to pay your income taxes on any withdrawal from your 401(k) account, regardless of the reason for the withdrawal. These taxes are due because you have not yet paid taxes on the money deposited in your 401(k) account. While you generally cannot avoid regular income taxes on the 401(k) withdrawal, you can, under certain circumstances, be excused from 10% additional tax penalty charged
on most early withdrawals. To my knowledge, using the money withdrawn from a 401(k) to purchase a home does not excuse one from the 10% penalty tax; such an exemption does exist for IRA accounts, but I do not believe that the same rule applies to 401(k) accounts. Therefore, you may be required to pay the taxes the IRS has claimed that you owe, unless your retirement account is not a 401(k), in which case different rules may apply. To read more about the rules regarding early withdrawals from tax-deferred retirement accounts, you can visit this link .
I think that the best thing you can do in this situation is to consult with a qualified tax attorney or certified public accountant. A professional tax advisor should be able to tell you what taxes you are required to pay, from what taxes you may be exempt, and how to assert any exemptions that you may have. You may also want to contact the IRS directly to discuss your situation and ask what taxes are legitimately owed; you can also review the IRS’s online information regarding 401(k)s at IRS.gov .
I wish you the best of luck in resolving this tax problem, and hope that the information I have provided helps you Find. Learn. Save.
Best,
Bill
www.bills.com/blog/
I think that the best thing you can do in this situation is to consult with a qualified tax attorney or certified public accountant. A professional tax advisor should be able to tell you what taxes you are required to pay, from what taxes you may be exempt, and how to assert any exemptions that you may have. You may also want to contact the IRS directly to discuss your situation and ask what taxes are legitimately owed; you can also review the IRS’s online information regarding 401(k)s at IRS.gov .
I wish you the best of luck in resolving this tax problem, and hope that the information I have provided helps you Find. Learn. Save.
Best,
Bill
www.bills.com/blog/
Also, make sure to get a free financial health check-up with Bills IQ!
User Comments
Your comments
Bill has answered thousands of money-related questions from readers on debt consolidation and settlement, home mortgage, credit reports and scores, auto and other loans, insurance, and others.
If you have a money question that has not been answered previously Ask Bill your question and be better informed.
Now get a free financial health check-up with Bills IQ!
Information provided by Bills.com is for general informational purposes only and is not be
construed as legal, financial, bankruptcy, tax or other professional advice. Should you
require more detailed information or specific professional advice tailored to your situation you
should consult an attorney, financial planner or tax advisor.
While we believe all information provided by Bills.com to be accurate as of the date of its posting, we cannot ensure its accuracy. Use of this site and any information contained on or provided through this site is provided without any representations, warranties or guarantees. Bills.com is not responsible or liable for any decisions or actions anyone may take based on the information provided. Please see Terms of Use.
While we believe all information provided by Bills.com to be accurate as of the date of its posting, we cannot ensure its accuracy. Use of this site and any information contained on or provided through this site is provided without any representations, warranties or guarantees. Bills.com is not responsible or liable for any decisions or actions anyone may take based on the information provided. Please see Terms of Use.
© 2006 - 2010Bills.com LLC. All Rights Reserved.
1. Posted by john on Thursday 26th February 2009 17:21
i reccommend anyone thinking of doing a 401k is not to do it! why, if you can make sure you put a % into a bank account you will be better of, then you won't have to pay 25%-35% tax when you withdraw it.
2. Posted by Frederic on Friday 27th February 2009 07:24
John, that tax penalty is not really a penalty in this case it is just a deferral of taxes. If you just put money into a bank account, it is after tax income so you are already penalized. If you company matches a 401-K is frequently your best investment (tax free contribution and matched!)
3. Posted by Dan Wilson on Saturday 7th March 2009 03:49
If I close out my 401K, which only has 16,000 dollars left in it, how much do I lose right away and how much would I have pay in tax at the end of the year?
4. Posted by Bill on Monday 9th March 2009 09:34
If you withdraw before you turn 59 & 1/2 years old, you will lose 10% right away. You would then receive a form 1099 for the $16000, which you would have to add on to your tax returns, and pay the taxes as per your tax bracket.
5. Posted by Amy on Sunday 14th June 2009 19:25
Hello, can a person close out there 401k plan for any reason? Meaning if i can't do a hardship withdrawel can i just close it out and get the money after penalty an tax. I am stuck for money an in my 20's. I have enough years to make the money up again. i have $22,000 in 401k Thank You
6. Posted by Bart Samo on Monday 15th June 2009 07:07
Yeah, you should call or contact your plan administrator. You own the 401k, so you can do whatever you want. You'll owe a hefty tax bill though, so be sure to save funds for tax day!