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?

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401k answers
Bill's Answer: Answered by Bills.com Staff

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 Taking money out of a 401(k) account can thus result in a tax obligation of 35% or more of the total amount withdrawn.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

Bills.com

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Comments (39)


Cristina G.
San Bernardino, CA  |  April 04, 2014
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.
Bills.com
April 04, 2014
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.
Leon B.
Grand Island, NE  |  April 01, 2014
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.
Bills.com
April 04, 2014
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.
Edna H.
Tulsa, OK  |  March 29, 2014
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?
Bills.com
March 30, 2014
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.
Vince F.
San Francisco, CA  |  September 09, 2013
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?
Bills.com
September 10, 2013
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.
Colleen M.
Sacramento, CA  |  May 21, 2013
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?
Bills.com
May 22, 2013
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.
Terry H.
April 07, 2013
Can you give me a simple explanation to the hardship rule? I'd just like to know if I can make withdrawls from my 401K if I'm fired from my job. Let's assume I've exhausted other avenues of relief such as savings, temporary loans and credit card cash advances. Thanks
Bills.com
April 11, 2013
The problem with simplifying IRS rules is doing so removes any nuances and exceptions. As we all know, tax laws are technical, and any simplification may mislead an honest person and lead them astray. Take the time to understand the rules the IRS shares in the document "401(k) Resource Guide - Plan Participants - General Distribution Rules," a link to which we share in the original article above.
Brad P.
Stagecoach, NV  |  February 22, 2013
Hello I'm 50 years old and have been working for a company for 15 yrs. I have a 401k that my employer is matching up to 6%.I currently have $300.000+ in my account. I'm looking at borrowing 30k to clear up my outstanding credit card debts. I’m told that the interest would be 4.2% which is a lot less than the 14 to 18 % that the cards are currently charging me. Is this a good idea. Also if I were to no longer work for the company in a year or so what would my penalties be. Could I pay the remaining balance off using money in my 401k and of course paying penalties and taxes. Just would like to know if the worst case (losing my job) and paying off the loan early would be better than having the high interest rates of the credit cards. I’m currently having trouble meeting my bills and other financial obligations each month .Needing away to lower my pay outs. Thanks you for any advise
Bills.com
February 25, 2013
Brad, check with your 401k plan administrator and find out the size of the repayment you would have to make on a 401k loan. Compare that payment to the size of the monthly credit card payments you currently make, to see which is better for your monthly cash flow. Because you state that you're having trouble making ends meet, it may not be a good decision to pay off the high-interest debt, even if it would save you money over the long haul, if it creates more stress month-to-month

If you leave your job, you either have a short time to repay the loan in full (I believe 3 months, but check with the plan administrator) or the unpaid portion counts as a withdrawal and is subject to both taxes and the 10% early-withdrawal penalty. Whether paying the taxes and penalties is better than paying the interest on the cards depends on different factors, including the total income you would show in any year in which the withdrawal counted as income.
Eugene P.
Irvine, CA  |  April 23, 2012
Hello, Please help me to understand my situation with early 401K withdrawal. I switched jobs in August of 2011 and we were planing to by a house so I made an early withdrawal from my 401 at 100%. We did not buy the house unfortunately. Let's say I had a total of $10,000 and only received $7,500 in cash due to tax paid for federal and state taxes. Now, when I prepared my taxes for 2011 I receive a form to add to my gross income $10,000. Does it mean that I'm getting double taxed on my withdrawal? Please help.
Bills.com
April 24, 2012
You are not being double-taxed. Just make sure to report the amount that was withheld. If you are confused, you should speak with a certified tax preparer to assist you. The last thing that you want to do is to make an error that will come back to bite you with additional penalties and interest.
Jason C.
Madison Heights, MI  |  April 16, 2012
I took a distribution when I left my last job. I paid 20% on that money. I knew I would pay another 10% at tax time. However, on top of that I'm also being taxed as income? so essentially, I'm paying 50%???? If i had $20K, and withdrew it, I should end up with $14K, correct? Instead, I'm paying taxes on that $14K, which will put me down to around $11K... Is this wrong???
Bills.com
April 16, 2012
You should add the amount you paid in taxes on the distribution in the "Other Taxes" section of your 1040. I believe it's line 58, if memory serves. You may also need to file a Form 5329.
Nathan M.
Brownsville, OR  |  April 05, 2012
I was fired form my job and had a 401k that my employer contributed to. After my release they took a large sum out only leaving about $4000 in the account. I transfered it to a IRA, but I am wondering what could I be looking at if I withdrew the money. I am 26 and am still unemployed and on unemployment. Unfortunately I need a car and need some money to buy a car, since I gave my car back to the bank because I couldn't afford the payment. How much would I possibly get back?
Bills.com
April 06, 2012
See the "Distributions" section in the original answer above for a general answer to your question. Exactly how much you will pay in taxes depends on your tax rate. You mentioned you are age 26. There is no exception from the penalty taxes you will pay if you use a distribution to purchase a vehicle if a person is less than age 59½.

Follow the links to the IRS documents above to learn more about 401(k) accounts and taking distributions from 401(k)s.
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