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.

Hot Definitions
  1. Efficiency Ratio

    Ratios that are typically used to analyze how well a company uses its assets and liabilities internally. Efficiency Ratios ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an ...
  4. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  5. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  6. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
Trading Center