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How Early 401K Withdrawals Can Affect Your Tax Return

How Early 401K Withdrawals Can Affect Your Tax Return

By on May 27, 2015 in Taxes | 0 comments

How Early 401K Withdrawals Can Affect Your Tax ReturnYour 401K retirement account is an excellent way to save for your retirement and some employers even match your contributions, giving you an extra boost for your nest egg. But, what happens if you come upon hard times before you retire and need to cash in some or all of your 401K?

Accessing these funds before you are 59 and a half may help you in the short term, but keep in mind that there are tax consequences for tapping into your retirement early. You want to make sure that you take these consequences into account ahead of time so that you are not hit with a hefty tax bill come April that creates another financial problem for you and your family.

Increased Taxable Income

 If you withdraw funds from your 401K before retirement, these funds become taxable income that’s added to your regular annual income. This is primarily because the contributions were not counted as taxable income when you put them into your retirement account. It is also possible that this additional taxable income can push you into a new tax bracket, also causing you to owe more to the IRS.

Early Withdrawal Penalties

When you take money out of your 401K early, you also will likely have to pay a penalty for doing so on top of paying the taxes already discussed. Most often, the penalty you’ll pay to the IRS is 10% of what you withdraw from your retirement account. So, if you take $10,000 out of your 401K, you will have to pay the IRS an additional $1,000 for the early withdrawal penalty.

Exceptions

There are some exceptions to the early penalty rule that you should be aware of. In these cases, you can take out as much as you need without penalty:

  • Permanent disability
  • If you have medical expenses that are more than 10% of your adjusted gross income
  • Domestic Relations Order by the court

Even if you qualify for one of these exceptions and your early withdrawal penalty is waived, you will still be responsible for the additional income taxes. So keep this in mind before withdrawing and make plans to pay the tax.

How to Make the Best Decision About Your 401K?

An early withdrawal from your 401K can be tempting, especially if you are experiencing a difficult financial time. Calculating whether the benefits of having the money early outweigh the potential tax implications is a difficult one. If you are unsure what is in your best interest, you may want to consider seeking some help and advice for how to proceed.

Success Tax Relief specializes in giving sound, honest advice to taxpayers. We’ll help you weigh all possible pros and cons so you can make an informed decision. We can also help you plan ahead if you decide to take an early withdrawal so that there is no reason to panic come tax time!

If you have questions about an early withdrawal and want to consult a tax professional, give us a call now at 877-825-1179.

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