Can you cash out your 401K tax free to pay medical bills?

Question

I have to have a $25,000 surgery not covered by insurance. I'm thinking of cashing out my 401K and someone told me that you can do it tax free for medical bills. Is this true?

I'm only 25 so it's not like I can't build back up my 401K...

Answer 1

Your source may be close to the truth, if your other income isn't too high.

Is the surgery deductible? Cosmetic surgery is not deductible. If you cash out your 401k for nondeductible medical expenses, you will pay income tax and a 10% penalty on the withdrawal.

I assume that you will have a $25,000 withdrawal for deductible medical expenses. To the extent that your medical expenses exceed 7.5% of your adjusted gross income, that amount of the withdrawal will not be subject to the 10% penalty. So the penalty in your example is .75% of your AGI. On a $50,000 AGI, that is just $375. Not much penalty at all.

The entire withdrawal figures into your AGI. But if you itemize (and you will with a medical bill this size), you will deduct your medical expenses which exceed 7.5% of your adjusted gross income. This can reduce most but not all of the tax on the withdrawal.

Answer 2

First, I am not advocating that you take the distribution. It will KILL your retirement savings!! Find another way to do it. If you can afford the loan payments, take a loan from your 401k instead. With that said, I'll answer your question as you asked....

No it's not true. You will still be subject to the tax. However, you may be able to avoid the 10% extra tax that's typically associated with early withdrawals. One of the exemptions is if the distribution is made for medical care but not in excess of amounts allowable as a deduction under Code Section 213.

Whether that's true for you or not, I don't know. Might be worth it for you to hire a tax accountant for this year.

You will still be obligated for the income taxes on the distribution. You have the choice to not have any money withheld from the distribution...but you'll still owe the income tax so that's not a good option to have. Better option is to take EXTRA. If you need 25k then take an extra 30% or 33k. Have the extra 8k submitted to the IRS for withholding. That of course assumes that you are obligated for the 10% extra tax.

Answer 3

Adding to jseah's answer, if you leave the company and take money out of your 401K and don't roll it over into a rolloever IRA or another employer's 401K, you will still pay the 10% penalty for early withdrawal if you're under 59-1/2.

There is an exception to the penalty for medical bills that exceed 7.5% of your income. You'd still pay the regular taxes in any case, but might avoid the penalty on part of it.

Good luck.

Answer 4

Most plans don't let you cash them out if you're still employed there. If you are no longer employed there, the HR department should be able to tell you how to do it - if there's no HR department look at your last 401K statement and call the number shown on the statement. Note: You'll pay income tax on the amount withdrawn, and if you're under age 59-1/2 you'll pay an additional 10% as a penalty for early withdrawal. A 401K is meant to be for retirement.

Answer 5

As per the instructions for IRS Form 5329 (page 6) you CAN avoid the EXTRA 10% penalty at tax time by withdrawing the amount of your medical bills MINUS the above stated percentages (10% as of 2014), however, you will still have to pay income tax in the percentage of your current tax bracket (i.e. 10%, 20% etcetera) on the amount you withdraw. You do not need to itemize to be eligible for this, but you cannot deduct 100% either.

Answer 6

I think they are thinking of a flex spending account or a cafeteria plan, where you put money into it from your paycheck tax free and you can take that out when you need it to pay for medical bills and such. Its like a reimbursement savings account.

Answer 7

There are reasons that fall under "hardship" that allow you to take money out of your retirement account. I urge you strongly to discuss with a CPA before you do this. The government's rules are pretty convoluted and the professionals can help you minimize the costs of doing such a thing.

Good luck with this.

Answer 8

No. If you use your 401K under a certain age, I think 60, you pay taxes. Your financial situation has nothing to do with it.

Answer 9

My advice would be to talk to someone familiar with your circumstances as well as current tax laws.

There are special withdrawal provisions available when there is a "immediate and heavy financial need" as defined by the IRS (see link).

Answer 10

No. Unless you meet the age requirement to start drawing money from your 401(k), you cannot take money out of your 401(k) except in the case where you leave the company.