A:

All 401(k) withdrawals are considered income and subject to income tax, including capital gains. When you take a premature distribution – a withdrawal before age 59.5 from a 401(k), IRA or any other tax-deferred retirement account or annuity – that withdrawal is also subject to an extra 10% penalty tax from the Internal Revenue Service (IRS).

When a 401(k) Loan Becomes a Taxable 401(k) Withdrawal

Some 401(k) plans let you take out loans from up to 50% of your available balance. If you cannot pay back the full balance of the loan within five years, then it is considered to be a withdrawal and is subject to income tax. If you are under age 59.5 at that time, then that early distribution is also subject to the 10% penalty fee.

Another instance in which a 401(k) loan becomes a taxable 401(k) withdrawal is if you cannot pay back the remaining balance of the loan upon termination of employment.

Exceptions to the Extra 10% Penalty Tax

While all 401(k) distributions are subject to income tax, there are several exceptions to the extra 10% penalty tax.

For example, if the amount of your unreimbursed medical expenses is more than 10% of your adjusted gross income (AGI) (7.5% if you are 65 or older) and you take a distribution from your 401(k) to cover those medical expenses, then the IRS exempts you from having to pay the extra 10% tax.

When you take a loan from your 401(k) for medical expenses, open a separate checking account to deposit the withdrawal and make the medical payments. By keeping a detailed paper trail of the use of your 401(k) funds, you can be ready in case of an IRS audit.

RELATED FAQS
  1. Can I take my 401(k) to buy a house for my children?

    Find out how you can use your 401(k) savings to fund the purchase of a home for your children, including the basics of standard ... Read Answer >>
Related Articles
  1. Retirement

    Your 401(k): Not the Best Emergency Fund

    If you have an emergency and need to access your retirement funds, you may have to pay a penalty if you dip into your 401(k). But there is a better option.
  2. Retirement

    When Paying Off Debt with Your 401(k) Makes Sense

    Experts warn against touching your retirement savings early, but there are situations where it is the best financial decision.
  3. Investing

    When Paying Off Debt With Your 401(k) Makes Sense

    It can be tempting to use funds from a 401(k) plan to pay debts. But first, it’s important to make sure it’s worth it.
  4. Taxes

    How 401(k) Withdrawals Work When You're Unemployed

    Unemployed individuals can pursue several options when taking money out of their 401(k), but they should carefully weigh taxes and possible penalties
  5. Retirement

    How Yearly Taxes on 401(k) Accounts Work

    Learn how your contributions to traditional or Roth 401(k) accounts are taxed, either in the year of contributions or at withdrawal, depending on the type.
  6. Retirement

    Foreign Citizen Alert: How Are Your 401(k) Withdrawals Taxed?

    As a U.S. nonresident, deciding what to do with your 401(k) after you return home comes down to which tax penalties, if any, you're willing to incur.
  7. Retirement

    What to Do With Your 401(k) if You Change Jobs

    There are several options for your old 401(k) if you start working for a new employer.
  8. Retirement

    4 Options for Your 401(k) When You Leave Your Job

    There are several options regarding your 401(k) plan when you leave a job, each with pros and cons.
  9. Retirement

    3 Reasons Your 401(k) Is Not Enough for Retirement

    Learn the basic structure of a 401(k), and a number of reasons why it may not be substantial enough to secure an individual's living upon retirement.
  10. Retirement

    Traditional or Roth 401(k), Which Is Better?

    When it comes to saving in 401(k) plans, using both a regular 401(k) and Roth 401(k) is best.
RELATED TERMS
  1. Hardship Withdrawal

    An emergency withdrawal from a retirement plan that may be subject ...
  2. 401(k) Plan

    A qualified plan established by employers to which eligible employees ...
  3. Withdrawal Penalty

    Refers to any penalty incurred by an individual for early withdrawal ...
  4. Tax Deferred

    Investment earnings such as interest, dividends or capital gains ...
  5. Early Withdrawal

    The removal of funds from a fixed-term investment before the ...
  6. Dynamic Updating

    A method of determining how much to withdraw from retirement ...
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  3. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
  4. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  5. Backward Integration

    A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it ...
  6. Pari-passu

    A Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors or obligations ...
Trading Center