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Taxation of 401(k) Loans & Withdrawals

Posted by Kamyar Mehdiyoun, Esq. | Sep 29, 2014

At one time or another, many individuals consider borrowing funds from their retirement accounts such as their 401(k) savings. They wonder what would be the tax consequences of such loans or withdrawals. Simply put, if the retirement plan allows such loans in the first place, and the individual abides by the terms of the loan, the borrowing would have no tax consequences. Violation of the retirement plan rules for loans or withdrawals, however, may result in a 10% penalty tax and also inclusion of the entire amount in the taxpayer's income in the year that he violated such rules. For example, if you borrow $10,000 from your 401(k) as a loan in 2015 and agree to pay it back in 2016 but fail to do so, you will be subjected to a 10% tax on the amount that you failed to repay if you are younger than 591⁄2. In addition the same amount should be included in your income in 2016.

If you intend to borrow from your retirement plan savings, you should first carefully study the provisions of your retirement plan document related to loans and premature withdrawals. Some retirement plans don't allow long-term borrowing. Individual Retirement Accounts (IRAs) are one such retirement plan. IRA account holders are required to return any withdrawals within 60 days. The same time limit applies if the IRA account holder intends to rollover some or all of his IRA savings to another retirement account. If he receives a check for the rollover amount and fails to deposit it in a new retirement account within the 60-day limit and he happens to be younger than 591⁄2, then he will be subjected to the 10% penalty tax. In addition, the entire amount will be included in his income in the year that he violated the 60-day rule. There are some exceptions to this 591⁄2 years rule. For example, if you use the funds to purchase or rebuild your first home, you will be exempt from the 10% tax penalty for premature withdrawal.

Tax consequences of premature withdrawals from retirement accounts such as 401(k) accounts are similar to loans from those accounts which are not repaid on time.

If you are concerned about tax consequences of loans and withdrawals from your retirement savings such as 401(k), IRA, ROTH IRA, SEP IRA, Thrift Savings Plans or similar accounts, contact our law firm. In addition to an LL.M. in taxation from Georgetown University Law Center, tax attorney, Kamyar Mehdiyoun, holds a certificate from the same institution in retirement and employee plans law and has assisted his clients in navigating the tax and retirement laws pertaining to taxation of retirement plans.

About the Author

Kamyar Mehdiyoun, Esq.

Kamyar Mehdiyoun, holds a Master of Law (LL.M.) degree in taxation from Georgetown University Law Center and focuses his practice on tax law. In 2003, he received the Award for Excellence in Tax Practice and Procedure from Georgetown. He also holds a Certificate in Employee Be...

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