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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 25223  
Subject: Re: 401k withdrawal question Date: 12/4/2012 2:31 PM
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She actually wants to withdraw everything so of the 13k left in the account she would automatically lose the 6k she borrowed and then have to pay taxes and penalty for 19k (6k loan + 13k balance) out of the remaining 7k. Is that correct?

Not exactly. The money for the loan was already withdrawn from her account, so she won't have to "pay back" the loan with money from her current $13k account balance. It will just be considered a withdrawal. (This assumes that her employer will allow her to default on the loan, and won't require her to continue paying back the loan as long as she's still employed.)

Assuming that she ends up withdrawing everything including the loan, she will owe Federal taxes at her marginal rate (probably at least 25%, or almost $5k), plus a 10% penalty (almost $2k), plus state taxes and penalties, if required by her state. As an example, if she lives in CA, she would probably be in the 9.3% marginal bracket, plus owe a 2.5% penalty, which would total about $2.2k. So, all in, her taxes and penalties would be around $9k, so she would have about $4k left from her $13k balance.

However, when sending her the money, the administrator of the plan is only required to withhold 20% ($3.8k) for Federal taxes, and often not required to withhold anything for state taxes. So, she would potentially end up with a little over $9k from the withdrawal, and a $5k tax bill that would come due in April. If she's not disciplined enough to put $5k of the $9k away for taxes, and NOT TOUCH IT, she's likely to be in much deeper trouble than she is now. And the IRS and state taxing authorities are not good creditors to have.

As far as her being 'only 55' - I presume you meant this in referring to her being exempt from the penalty. However, at 55, if she has little/no other retirement money set aside, she actually has very little time to replace this $19k before she actually retires.

I can think of very few reasons that it would be a good idea in the long run for her to take the course of action that she's proposing - possibly life-saving medical treatments (although those may be able to be put on a payment plan) or paying off a tax lien (although that may also be able to be put on a payment plan).

AJ
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