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Information on Tax Obligation Due to 401K Withdrawal

If I withdraw from my 401K to buy a house, am I still liable for the penalty?

Bill, I have a question for you. I bought a condominium a year and a half ago. I took the down-payment 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?

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401k answers

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. 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 current, 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 read the IRS document Topic 424 - 401(k) Plans.

Distributions

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 Taking money out of a 401(k) account can thus result in a tax obligation of 35% or more of the total amount withdrawn.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 Congress wrote into the 401(k) law are designed to discourage Americans from making premature withdrawals from their 401(k) accounts. 401(k)s are designed to help workers save for retirement and not as a means of saving for other purposes.

You will almost always be required to pay some 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 read more about the rules regarding early withdrawals from tax-deferred retirement accounts, read the IRS document 401(k) Resource Guide - Plan Participants - 401(k) Plan Overview and 401(k) Resource Guide - Plan Participants - General Distribution Rules.

Your Next Steps

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. Also review the IRS’s 401(k) Resource Guide.

I hope this information helps you Find. Learn & Save.

Best,

Bill

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39 Comments

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  • CG
    Apr, 2014
    cristina
    I'm 26 and recently quit my job cause I had a baby and had no one to watch her. I have a 401k with an outstanding loan. My 401 k has 14k and the outstanding loan is for 3k. I was told I could pay the 3k right now or if I can't, the 3k will be counted as my salary wage for this year. If I don't pay the 3k, I was told I would pay 4k in taxes from the 14k in the 401k leaving me with 10k.I plan to withdrawl everything I can from it but what's better to do, pay the 3k right now or have it counted as salary? And if I pay for the outstanding loan balance, and pay all the taxes they'll charge me, do I still have to pay taxes for next year? I'm very confused.
    0 Votes

    • BA
      Apr, 2014
      Bill
      It's difficult to give you tax advice based on incomplete information. The smartest thing you can do is exactly what a tax pro would do. Complete two or more mock tax returns for 2015. In one, do a complete distribution of your 401(k). In the other do a partial distribution and roll-over into an IRA. Play what-ifs to learn which results in the lowest tax liability.
      0 Votes

  • LB
    Apr, 2014
    Leon
    I am 61 years old and have a $78,000.00 in my 401K. I am leaving the company and want to roll over my 401K to an IRA and then take monthly withdrawals. Probably $2000.00 a month until I reach 62 in November. Then I will take early retirement and withdraw less each month. How much tax can I expect to have taken out each month.
    0 Votes

    • BA
      Apr, 2014
      Bill
      Difficult for us to answer detailed tax questions like yours because we rarely have enough information about the reader's total financial picture. Consult with a tax planner. He or she will play what-if scenarios, and give you advice on what you should set aside from your 401(k) distributions for state and federal income taxes.
      0 Votes

  • EH
    Mar, 2014
    Edna
    I accidentally clicked on the button that added an additional 20% to the required 20% federal taxes. They will not refund the additional 20% back. However, they told me that if I paid above my tax bracket which is 15%, I will get the money back from my tax refund. Is that true? If so, the additional 20% I paid was approximately $4000. 20% of $4000 is $600, which I will get at least $3,400 back. Is that correct?
    0 Votes

    • BA
      Mar, 2014
      Bill
      If you overpay on your taxes (and you don't have a balance owing to the IRS or any entity entitled to make a claim), then you will get a refund. In your specific scenario, how much you get back depends on your total owed and what was withheld from your income. Without knowing all the details on your return, it isn't possible to say exactly how much you will get back.
      0 Votes

  • VF
    Sep, 2013
    Vince
    I currently am investing money into a different savings account in which i cannot roll my 401k over to. Its not much by any means and am considering withdrawing. I live in california and my 401k plan is only worth $5119.49. how much will i come away with after taxes and penalties?
    0 Votes

    • BA
      Sep, 2013
      Bill
      Vince, I can't give you an exact figure. You will be obligated to pay a 10% penalty, when you file your 2013 return. When you take the funds, it is likely that you will be required to have 20% withheld which will be applied to your taxes due. How much you end up owing depends on your tax bracket and the deductions you will be entitled to claim. As a rough estimate, expect that you will lose 35-40% in taxes in penalties.
      0 Votes

  • CM
    May, 2013
    Colleen
    I incurred an IRS tax debt for the tax year 2011 which I filed the return for 2011 in October of 2012. I was married in April of 2012. Is my husband responsible for my 2011 tax debt?
    0 Votes

    • BA
      May, 2013
      Bill
      Your husband is not responsible for your tax debt, but if the IRS moves to levy a bank account that has both your names on it, money from the account would be seized to pay the debt, regardless of whether the money was from his paycheck or yours. Also, if you file a joint return, a refund could be used to pay what you owe.

      I advise you to set up an installment agreement with the IRS, to avoid any collection efforts.
      0 Votes