401K Emergency withdrawel?

July 21, 2007 10:37 PM

A tax question. Our family has experienced a drop in income and an emergency (not medical). I have a 40 thousand dollar 401K retirement fund and want to get 16K out of it. Our family makes 91K gross with two dependents. What will be the tax hit on the 15 k from the retirement fund (so we won't be surprised at tax time).

I know it isn't advisable under any circumstances to remove money from a 401K but there may be no other way to do this, though it will be our last choice. I am also trying to find a tax attorney or some other less expensive route to ask this question of. I just need a bit of peace of mind so I can figure out my options. One of the two dependents is a laid off adult so there might be a chance to take the payout from the 401 k under married filing separately at a lower (read no income) tax bracket?

posted by anonymous to law & government (6 comments total)

You can look into getting a loan from your plan if you expect to remain with this company until you can repay it back to yourself.

Withdrawals IME are subject to a 20% withholding off the top, and the entire sum is treated as income to you for the tax year you get it.

In addition, there is a 10% penalty for early withdrawal, but this 10% penalty is deductible so it works out to a ~7.5% penalty.

If you time it right -- early in the tax year, and the withdrawer not receiving any other taxable income that year -- then you would in fact benefit from the lower marginal rates. I pulled this trick some years ago to move 38% money to ~12% net tax rate.

But I know nothing about married vs. singe filing so that's something somebody else is going to answer.
posted by Heywood Mogroot at 10:50 PM on July 21, 2007 [1 favorite]

Most plans do have some kind of hardship withdrawal. Yes, medical is one of the reasons, but there are usually others as well...Call customer service at your plan and check this out...

E.g., here's Fidelity's
posted by poppo at 4:02 AM on July 22, 2007

Is the 10% penalty on the interest earned or on the amount removed? Seems rather harsh if it is the latter.
posted by Gungho at 5:57 AM on July 22, 2007

It's harsh to encourage you to keep the money until you actually retire. The loan is the way to go.
posted by caddis at 6:50 AM on July 22, 2007

non-medical hardship withdrawals still get hit with the penalty.
posted by Heywood Mogroot at 12:07 PM on July 22, 2007

In addition to the tax ramifications listed above, you should also consider the true cost of what this will cost you.

Keep in mind that your 401(k) is funded with pre-tax monies. This is money that you have never paid taxes on. When you take a loan out of it, in addition to paying penalties and whatnot, you will be repaying this loan with after-tax money. This is money that you get via paycheck which has already been taxed. What this means is that when you're old enough to finally take from this 401(k) (at retirement), you will pay income tax on it again. You are volunteering for double taxation. We don't want to pay taxes to begin with, why would you want to pay it twice?

Another thing to keep in mind is that there is a time limit to how long you have to pay this money back to the 401(k). If it's 5 years and you're staying at your job for that long, that's great. But what if you get laid off? Chances are, you'll have less than 1 year to pay this loan back. Check with your institution to find out how long you have if you get laid off to pay this loan back.

Lastly, with all the present and future tax consequences and penalties in mind, is there some other way for you to get a loan? Maybe a home equity loan or a private loan from family or friends? Perhaps sell that extra car that you might not need?

Good luck.
posted by pikaboy202 at 3:25 PM on July 22, 2007