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401K Early Withdrawal LifeBack Tax
If you're desperate for funds and considering cashing your 401k plan early, be aware that early distributions from a retirement plan can have unexpected consequences. Aside from having fewer savings set aside for retirement, early 401k withdrawals can lead to tax problems with the Internal Revenue Service.
First of all, any funds withdrawn from a 401k are subject to income tax, just like a paycheck. This is because income placed in a 401k plan is "tax-deferred", meaning that it isn't taxed until distributed. After retiring, you will likely be in a lower tax bracket, reducing how much you owe in taxes on your 401k distributions. On the other hand, if you withdraw from your 401k while still working, those funds are taxed at your current bracket's rate, and may even push your annual income into the next tax bracket.
On top of this, the IRS also charges an additional 10 percent penalty tax for withdrawing from a retirement account before retirement age, defined as age 59 1/2. If this penalty is not withheld from your distribution along with regular income tax, you may find yourself owing the IRS without realizing. Between increased tax liabilities and the early-distribution penalty, withdrawing from your 401k early may provide you with far fewer funds than anticipated.
However, there are several exceptions to the early-distribution penalty. Generally speaking, retirement plans allow funds to be withdrawn without penalty if the plan owner becomes totally and permanently disabled. Your estate may also receive penalty-free distributions from your retirement plan after your death.
For a 401k, one exception is called the "separation from service" rule: If you separated from employment at age 55 or older, you may take distributions from the 401k plan with that employer without owing a penalty. However, you will still need to pay income tax on these 401k distributions and report them on your annual tax return.
Depending on your employer, you may be permitted to borrow from your 401k plan while employed. This can provide an way of accessing funds in your 401k account without owing income tax. However, you will need to repay the loan with interest within the terms given, or the IRS will treat the unpaid loan as a distribution and apply tax and penalties accordingly. You also may become due for the full loan balance if you leave your job before repaying the loan.
If you currently owe back taxes to the IRS due to early 401k withdrawals, please contact us at LifeBack Tax Relief. The IRS has numerous tactics at their disposal to punish taxpayers for unpaid taxes. We can protect you from tax liens, bank levies, and wage garnishments, and will negotiate with the IRS on your behalf to resolve your tax problems.
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