Can the irs take my 401k if i owe taxes

If you're allowed to take a distribution from your 401(k), you can pay the Internal Revenue Service -- or anyone else -- with the proceeds. When you do take out money, it isn't treated differently for income tax purposes just because you're paying your taxes with it. You might, however, get a small break if the IRS is taking money out of a 401(k) with a levy.

Índice Show

Distributions
Early Withdrawal Penalty
IRS Levy Exception
Taxes on 401(k) contributions
Taxes on 401(k) withdrawals
If you withdraw the money early
If you withdraw the money when you retire
Taxes on Roth 401(k) plans
Roth 401(k) vs. traditional 401(k)
7 ways to reduce your 401(k) taxes

Distributions

If you're at least 59 1/2 years old, your 401(k) plan is yours to use as you see fit whenever you want, and that includes taking out money if you want to pay off Uncle Sam. If you haven't reached the magic age yet, you can only take money out of your 401(k) plan under certain circumstances -- for example, after you've left your job, suffered a permanent disability or experienced a financial hardship. The IRS does state, in its general distribution rules for 401(k) plans, that amounts drawn due to financial hardship "may include any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution." However, 401(k) plans are not required to allow such hardship distributions -- some plans do and some don't.

Taxes

Just because you're taking money out of your 401(k) plan to pay your taxes doesn't mean you get out of the taxes on the distribution. For example, say you're taking out $9,000 to pay the IRS. If you fall in the 25 percent tax bracket, you're going to owe an extra $2,250 in income taxes in the year you took the money out, because the withdrawal counts as taxable income.

Early Withdrawal Penalty

If you're under 59 1/2, you might also be slapped with a 10 percent additional tax on your 401(k) distribution because you're taking an early withdrawal. For example, if you take out $9,000 to pay the IRS, you're going to have to pay an extra $900 on top of the income taxes. If you're over 59 1/2, permanently disabled or you retired after you turned 55, you don't have to pay the penalty.

IRS Levy Exception

If the IRS levies your 401(k) plan specifically, any distributions used to pay off the levy aren't hit with the 10 percent early withdrawal penalty. But, that doesn't mean the IRS will just take the money out unannounced. Instead, you receive a notice of the tax due and the IRS informs you of its intent to levy your 401(k) plan before taking the money, so you have a chance to pay it with other funds if you want. However, if the IRS just sends you a tax bill, or levies other property but not your 401(k) plan, you don't have an exception to the early withdrawal penalty if you use 401(k) plan money to pay it off. It only works if the IRS is the one to take the money out.

References

Writer Bio

Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

Most 401(k) plans are tax-deferred. This means that you don’t pay taxes on the money you contribute — or on any gains, interest or dividends the plan produces — until you withdraw from the account.

That makes the 401(k) not just a way to save for retirement; it’s also a great way to cut your tax bill. But there are a few rules about 401(k) taxes to know, as well as a few strategies that can get your tax bill even lower.

Here’s an overview of how 401(k) taxes work, how a 401(k) can affect your tax return and how to pay less tax when the IRS asks for a cut of your retirement savings.

» Use our 401k calculatorto see if you're on track for retirement

Taxes on 401(k) contributions

Contributions to a traditional 401(k) plan come out of your paycheck before the IRS takes its cut. You’ll sometimes hear this referred to as “pre-tax income,” and it means two things: 1) you won’t pay income tax on those contributions, and 2) they can reduce your adjusted gross income.

An example of how this works: If you earn $50,000 before taxes and you contribute $2,000 of it to your 401(k), that's $2,000 less you'll be taxed on. When you file your tax return, you’d report $48,000 rather than $50,000.

A few other notable facts about 401(k) contributions:

In 2022, you can contribute up to $20,500 a year to a 401(k) plan. If you're 50 or older, you can contribute $27,000.
The annual contribution limit is per person, and it applies to all of your 401(k) account contributions in total.
You still have to pay some FICA taxes (Medicare and Social Security) on your payroll contributions to a 401(k).
Your employer will send you a W-2 in January that shows how much it paid you during the previous calendar year, as well as how much you contributed to your 401(k) and how much withholding tax you paid.

See more ways to save and invest for the future

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Taxes on 401(k) withdrawals

If you withdraw the money early

Taxes will be withheld. The IRS generally requires automatic withholding of 20% of a 401(k) early withdrawal for taxes. So if you withdraw the $10,000 in your 401(k) at age 40, you may get only about $8,000.
The IRS will penalize you. If you withdraw money from your 401(k) before you’re 59½, the IRS usually assesses a 10% penalty when you file your tax return. That could mean giving the government another $1,000 of that $10,000 withdrawal.
You will have less money for later, especially if the market is down when you start making withdrawals. That could have long-term consequences.

There are a lot of exceptions. This article has more details, but in a nutshell, you might be able to escape the IRS’s 10% penalty for early withdrawals from a traditional 401(k) if you:

Receive the payout over time.
Qualify for a hardship distribution with the plan administrator.
Leave your job and are over a certain age.
Are getting divorced.
Give birth to a child or adopt a child.
Are or become disabled.
Put the money in another retirement account.
Use the money to pay an IRS levy.
Use the money to pay certain medical expenses.
Were a disaster victim.
Overcontributed to your 401(k).
Were in the military.
Die.

If you withdraw the money when you retire

For traditional 401(k)s, the money you withdraw (also called a “distribution”) is taxable as regular income — like income from a job — in the year you take it. (Remember, you didn’t pay income taxes on it back when you put it in the account; now it’s time to pay the piper.) You can begin withdrawing money from your traditional 401(k) without penalty when you turn age 59½. The rate at which your distributions are taxed will depend on what federal tax bracket you fall in at the time of your qualified withdrawal.

A few important points:

If you don’t take the required minimum distribution when you’re supposed to, the IRS can assess a penalty of 50% of the amount not distributed.
You can withdraw more than the minimum.

Taxes on Roth 401(k) plans

Some employers offer another type of 401(k) plan called a Roth 401(k). These savings plans take the opposite approach when it comes to taxation: They’re funded by post-tax income. This means your contributions won’t lower your AGI ahead of tax-filing season.

The biggest benefit of a Roth 401(k) is that because you’re paying taxes on your contributions now, you can withdraw the money tax-free later. A few other important notes:

You can begin withdrawing money from your Roth 401(k) without penalty once you’ve held the account for at least five years and you’re at least 59½.
You can withdraw money from a Roth 401(k) early if you’ve held the account for at least five years and need the money due to disability or death.
Roth 401(k)s also require taking RMDs.

Roth 401(k) vs. traditional 401(k)

Traditional 401(k)

Roth 401(k)

Tax treatment of contributions

Contributions are made pre-tax, which reduces your current adjusted gross income.

Contributions are made after taxes, with no effect on current adjusted gross income. Employer matching dollars must go into a pre-tax account and are taxed when distributed.

Tax treatment of withdrawals

Distributions in retirement are taxed as ordinary income.

No taxes on qualified distributions in retirement.

Withdrawal rules

Withdrawals of contributions and earnings are taxed. Distributions may be penalized if taken before age 59½, unless you meet one of the IRS exceptions.

Withdrawals of contributions and earnings are not taxed as long as the distribution is considered qualified by the IRS: The account has been held for five years or more and the distribution is:

Due to disability or death
On or after age 59½

Unlike a Roth IRA, you cannot withdraw contributions any time you choose.

7 ways to reduce your 401(k) taxes

Wait. Don’t dip into your account if you can help it. Withdrawals, especially early ones, can trigger taxes.
Look for exceptions. If you must make an early withdrawal from a 401(k), see if you qualify for an exception that will help you avoid paying an early withdrawal penalty.
Consider credits. See if you qualify for the saver’s credit on your contributions.
Know the rules about 401(k) rollovers. Rolling a 401(k) account into another 401(k) or into an IRA usually won’t trigger taxes — if you get the money into the new account within 60 days. Otherwise, the IRS might consider the move a distribution, triggering taxes and maybe even a penalty.
Borrow from your 401(k) instead of making an early withdrawal. Not all 401(k) plans offer loans, though. Also, in most circumstances, you’ll need to repay the loan within five years and make regular payments. Check with your plan administrator for the rules.
Use tax-loss harvesting. You might be able to offset the taxes on your 401(k) withdrawal by selling underperforming securities at a loss in some other regular investment account you might have. Those losses can offset some or all of the taxes on your 401(k) withdrawal.
See a tax professional. There are other ways to minimize your 401(k) taxes, too, so find a qualified tax pro and discuss your options.