Author Topic: How to withdraw from 401K without penalty/or taxes?  (Read 1462 times)

flowerofsun

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How to withdraw from 401K without penalty/or taxes?
« on: November 19, 2018, 12:11:13 AM »
Hi guys!
I am new on this forum so I apologize if I sound dumb. I have a hard time expressing my thoughts.

I have taken a loan from my 401k in the past (it was pretax money) but when I was returning them, it was after tax money.

I am in a 30% tax bracket, so if I take out 10K from 401K then in order to return those 10K I have to return 13K (because I am in 30% tax bracket and after taxes 10K will be 13K). When I retire I will be taxed on that money again. So its like double taxation

I need to take another loan or withdraw money from my 401K, is there a way to do it without paying penalty or taxes? (I am not 59 years old yet)

I hope it makes sense what I am trying to ask...
Thank you so much!

flowerofsun

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #1 on: November 19, 2018, 12:21:30 AM »
Forgot to mention that I do not qualify for Roth not sure about SEPP..
Also, money in Roth need to sit for 5 years, but I need the money now...

flowerofsun

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #2 on: November 19, 2018, 12:29:56 AM »
For instance, my understanding that I could take money without returning for health issues, is that right?
ALso, first time home buyer. My understanding, even if a person owned homes in the past somehow they can be considered as a first time home buyer if they did not buy a primary residence within last 5 years or so, is that right?

jacoavluha

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #3 on: November 19, 2018, 07:52:56 AM »
it is not double taxation. you received a deduction at the time of original contribution of the funds to the 401k. when the money is eventually distributed from the 401k or legacy rollover IRA (not as a loan), you will be taxed. At no time in between is there an effect on your tax return.

flowerofsun

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #4 on: November 20, 2018, 12:46:08 AM »
it is not double taxation. you received a deduction at the time of original contribution of the funds to the 401k. when the money is eventually distributed from the 401k or legacy rollover IRA (not as a loan), you will be taxed. At no time in between is there an effect on your tax return.
Thank you!
Sorry, I am not really smart, so I have a hard time understanding...Can you please explain in numbers?
If I took 10K as a loan from my 401K, these money were before tax, right?
Lets say within 1o month  I have to return them. So, are you saying that I am returning  1K per month before tax money?

MustacheAndaHalf

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #5 on: November 20, 2018, 04:00:24 AM »
Think of the long term here.  Are you saying you had two emergencies that could only be solved with 401(k) money?  I think you need to save up money outside your 401(k).  You need an emergency fund.

Your 401(k) has bankruptcy protection, so if you keep money in there it can survive bankruptcy.

I see two opinions on the internet, which take contrary views, and I agree with both.  So here they are:
* you are getting double taxed: you repay the loan with after-tax dollars.  When you pull that money out at retirement, it gets taxed again.
* it's all after-tax dollars anyways: if you pull $10,000 from your 401(k), you need $10,000.  You can repay the loan with after-tax $10,000 or you can take $10,000 after tax dollars and buy the thing directly.  Ultimately $10,000 in after-tax money has to get involved at some point.

jacoavluha

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #6 on: November 20, 2018, 06:50:48 AM »
401k loans are not double taxed, not that they're a good idea, but they're not double taxed

consider you take a loan, and the funds that come out from the loan go in your left pocket, and funds from your paycheck go in your right pocket

you take a $10k loan, your 401k is $10k less, you have $10k in your left pocket. No effect yet on your taxes.

over the course of 6 months you earn $14k, you pay $4k in taxes, $10k remains and that goes in your right pocket

now you repay the loan. $10k goes back into the 401k. You're left with $10k. Which pocket does it come from?

Doesn't matter. But in the end, the loan funds aren't taxed.




flowerofsun

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #7 on: November 23, 2018, 01:53:08 AM »
401k loans are not double taxed, not that they're a good idea, but they're not double taxed

consider you take a loan, and the funds that come out from the loan go in your left pocket, and funds from your paycheck go in your right pocket

you take a $10k loan, your 401k is $10k less, you have $10k in your left pocket. No effect yet on your taxes.

over the course of 6 months you earn $14k, you pay $4k in taxes, $10k remains and that goes in your right pocket

now you repay the loan. $10k goes back into the 401k. You're left with $10k. Which pocket does it come from?

Doesn't matter. But in the end, the loan funds aren't taxed.

I may be missing something...
Here is my understanding:

3 pockets.
Pocket one:
10 K Loan is in left pocket

Pocket 2:
Lets say I am making 115K then 115K-15K  (which is what I am putting before taxes into right pocket)=100k is my taxable income. I am in 30% tax bracket so 100k-30%=70K...

Pocket 3:
Now I put this 70K in my third pocket lets say my back pocket, which is called after tax money) then from this money I pay 10K loan (which is after tax money)


In couple of decades I retire, when I am 65 years old) and will have to pay taxes again at whatever rate I will be at retirement.
So I paid taxes on that loan already, and will pay taxes again when I retire, right?
What am I missing?



flowerofsun

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #8 on: November 23, 2018, 01:55:06 AM »
Think of the long term here.  Are you saying you had two emergencies that could only be solved with 401(k) money?  I think you need to save up money outside your 401(k).  You need an emergency fund.

Your 401(k) has bankruptcy protection, so if you keep money in there it can survive bankruptcy.

  You can repay the loan with after-tax $10,000 or you can take $10,000 after tax dollars and buy the thing directly.  Ultimately $10,000 in after-tax money has to get involved at some point.
Very good point! I have not thought about it!
Thank you!

jacoavluha

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #9 on: November 23, 2018, 07:16:00 AM »
401k loans are not double taxed, not that they're a good idea, but they're not double taxed

consider you take a loan, and the funds that come out from the loan go in your left pocket, and funds from your paycheck go in your right pocket

you take a $10k loan, your 401k is $10k less, you have $10k in your left pocket. No effect yet on your taxes.

over the course of 6 months you earn $14k, you pay $4k in taxes, $10k remains and that goes in your right pocket

now you repay the loan. $10k goes back into the 401k. You're left with $10k. Which pocket does it come from?

Doesn't matter. But in the end, the loan funds aren't taxed.

I may be missing something...
Here is my understanding:

3 pockets.
Pocket one:
10 K Loan is in left pocket

Pocket 2:
Lets say I am making 115K then 115K-15K  (which is what I am putting before taxes into right pocket)=100k is my taxable income. I am in 30% tax bracket so 100k-30%=70K...

Pocket 3:
Now I put this 70K in my third pocket lets say my back pocket, which is called after tax money) then from this money I pay 10K loan (which is after tax money)


In couple of decades I retire, when I am 65 years old) and will have to pay taxes again at whatever rate I will be at retirement.
So I paid taxes on that loan already, and will pay taxes again when I retire, right?
What am I missing?

Your income was taxed, not the loan. You said it yourself.

Think of a loan from a bank. You sign papers. You get $10k cash. You pay back the loan, with after tax money of course. Is that “double taxed?” No. A 401k loan is no different. Except you are also the bank.

flowerofsun

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #10 on: November 27, 2018, 11:32:49 PM »
401k loans are not double taxed, not that they're a good idea, but they're not double taxed

consider you take a loan, and the funds that come out from the loan go in your left pocket, and funds from your paycheck go in your right pocket

you take a $10k loan, your 401k is $10k less, you have $10k in your left pocket. No effect yet on your taxes.

over the course of 6 months you earn $14k, you pay $4k in taxes, $10k remains and that goes in your right pocket

now you repay the loan. $10k goes back into the 401k. You're left with $10k. Which pocket does it come from?

Doesn't matter. But in the end, the loan funds aren't taxed.

I may be missing something...
Here is my understanding:

3 pockets.
Pocket one:
10 K Loan is in left pocket

Pocket 2:
Lets say I am making 115K then 115K-15K  (which is what I am putting before taxes into right pocket)=100k is my taxable income. I am in 30% tax bracket so 100k-30%=70K...

Pocket 3:
Now I put this 70K in my third pocket lets say my back pocket, which is called after tax money) then from this money I pay 10K loan (which is after tax money)


In couple of decades I retire, when I am 65 years old) and will have to pay taxes again at whatever rate I will be at retirement.
So I paid taxes on that loan already, and will pay taxes again when I retire, right?
What am I missing?

Your income was taxed, not the loan. You said it yourself.

Think of a loan from a bank. You sign papers. You get $10k cash. You pay back the loan, with after tax money of course. Is that “double taxed?” No. A 401k loan is no different. Except you are also the bank.

Exactly! But the 10K that initially were deposited into my 401K account before I took the loan out were pre-tax money! Correct?
So I took out 10K of pretax money but have to return back 10K after tax money (which is 13K if I am in a 30% tax bracket roughly). Then when I retire it will get taxed again.
That is so not fair!

If I had Roth, the situation would be different, right? I would get taxed only once?
Lets say I have 10K in Roth, that 10K was 13K before taxes were taken out (if I am in a 30% tax bracket, roughly), right? 

Lets say I take that 10K out as a loan (its 10K of after tx money) and I am returning it back also as 10K of after tax money, right?

Hey guys, if I like to take loans from my 401K or Roth, is it better to use Roth for loans or 401K for loans?

reeshau

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #11 on: November 28, 2018, 02:57:04 AM »
Exactly! But the 10K that initially were deposited into my 401K account before I took the loan out were pre-tax money! Correct?
So I took out 10K of pretax money but have to return back 10K after tax money (which is 13K if I am in a 30% tax bracket roughly). Then when I retire it will get taxed again.
That is so not fair!

If I had Roth, the situation would be different, right? I would get taxed only once?
Lets say I have 10K in Roth, that 10K was 13K before taxes were taken out (if I am in a 30% tax bracket, roughly), right? 

Lets say I take that 10K out as a loan (its 10K of after tx money) and I am returning it back also as 10K of after tax money, right?

Hey guys, if I like to take loans from my 401K or Roth, is it better to use Roth for loans or 401K for loans?

You are hung up on a piece of the transaction.  But the loan is just an intermediate step.  The transaction was that you bought something.  You bought it with post-tax money, like you buy almost everything.  You just happened to have this loan process in the middle, which has you tied up in knots.  So, when you spent it, you "owed" tax on that money.  When you replaced it, you made up for that, too.

pre-tax money (loan) -> post-tax purchase  ("owed")

post-tax loan repayment -> repaid pre-tax loan

Net double taxes: 0

Scandium

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #12 on: November 28, 2018, 06:54:18 AM »
You make over $150,000 (or $300k+ jointly) and you have to take a 401k loan for 10 grand?! I think you have bigger issues than how you are taxed..

(32% bracket starts around $157k AGI)

nereo

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #13 on: November 28, 2018, 07:03:01 AM »

Exactly! But the 10K that initially were deposited into my 401K account before I took the loan out were pre-tax money! Correct?
So I took out 10K of pretax money but have to return back 10K after tax money (which is 13K if I am in a 30% tax bracket roughly). Then when I retire it will get taxed again.
That is so not fair!


I think what you are missing is the concept of fungibility in money.
You take out $10k which was pre-tax - and you can then spend that pre-tax money and replace it with post-tax money later. 
Which is the same thing as saying you take out $10k in pre-tax money and you return that same pre-tax money to your 401(k).

either way, you avoided paying taxes on $10k worth of income.

You aren't taxed twice.

Dabnasty

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #14 on: November 28, 2018, 07:13:01 AM »
Exactly! But the 10K that initially were deposited into my 401K account before I took the loan out were pre-tax money! Correct?
So I took out 10K of pretax money but have to return back 10K after tax money (which is 13K if I am in a 30% tax bracket roughly). Then when I retire it will get taxed again.
That is so not fair!

If I had Roth, the situation would be different, right? I would get taxed only once?
Lets say I have 10K in Roth, that 10K was 13K before taxes were taken out (if I am in a 30% tax bracket, roughly), right? 

Lets say I take that 10K out as a loan (its 10K of after tx money) and I am returning it back also as 10K of after tax money, right?

Hey guys, if I like to take loans from my 401K or Roth, is it better to use Roth for loans or 401K for loans?

You are hung up on a piece of the transaction.  But the loan is just an intermediate step.  The transaction was that you bought something.  You bought it with post-tax money, like you buy almost everything.  You just happened to have this loan process in the middle, which has you tied up in knots.  So, when you spent it, you "owed" tax on that money.  When you replaced it, you made up for that, too.

pre-tax money (loan) -> post-tax purchase  ("owed")

post-tax loan repayment -> repaid pre-tax loan

Net double taxes: 0

This covers it but just in case I wanted to word this another way, this is the simplest form I can come up with.

Any cash you have on hand has been taxed. You either spend $10,000 cash or you spend a $10,000 loan and repay the loan with $10,000 cash (+ interest).

Mentally, you can disconnect the fact that the loan is coming from your 401k. It's no different than if you got the loan from a bank, you pay it back with post tax money.

Pocket 2:
Lets say I am making 115K then 115K-15K  (which is what I am putting before taxes into right pocket)=100k is my taxable income. I am in 30% tax bracket so 100k-30%=70K...

Also want to add, this is not how income tax is calculated. You would pay a portion within each tax bracket as you go up.

If you are preparing to take a loan from your 401k, or even if you're not for that matter, you could greatly benefit from understanding how your taxes are calculated. It may seem daunting at first but it's all very basic math and there really aren't that many rules for basic earned income.

Dicey

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #15 on: November 28, 2018, 08:07:50 AM »
401k loans are not double taxed, not that they're a good idea, but they're not double taxed

consider you take a loan, and the funds that come out from the loan go in your left pocket, and funds from your paycheck go in your right pocket

you take a $10k loan, your 401k is $10k less, you have $10k in your left pocket. No effect yet on your taxes.

over the course of 6 months you earn $14k, you pay $4k in taxes, $10k remains and that goes in your right pocket

now you repay the loan. $10k goes back into the 401k. You're left with $10k. Which pocket does it come from?

Doesn't matter. But in the end, the loan funds aren't taxed.
OP, from a mustachian POV, your question makes me wonder if you're living above your means. Instead of telling you how to do this, I recommend a thorough examination of what it it is you want to buy that you don't have the money for.
--------------------
In the example quoted above, the money in your right pocket was taxed $4k. When you withdraw the money,  there is no provision for the fact that taxes were paid on the money that was used to repay the tax free money from the loan.

I've had this conversation with the great @Cheddar Stacker on this forum before. He's mostly inactive now, but he's a very wise and mustachian CPA. I still don't quite get it. MustacheAndaHalf points this out as well. I get that the loan isn't double taxed, but the money I paid it back with sure as hell was post tax. Had a person not borrowed pre-tax money, they wouldn't need to pay it back with post-tax dollars, hence the conundrum.

More cons:
-The money you've borrowed is out of the market, so you're losing on potential gains.
- Borrowing from a Roth has the same time-out-of-market problem.
- Cashing out a Roth is worse in the long term, because you can't put it back into the Roth.
- 401k loans typically have a short payback preriod should you separate from the company.

Finally, this: I borrowed from my 401k once and consider it the biggest mistake of my financial life. I only borrowed $6k and I used it for a property that doubled in price when I sold it four years later, but damn, I hated feeling like an indentured servant. I paid that fucker off with "gazelle-like intensity" within the year and never tapped it again. In retrospect, I wish I had borrowed it from my parents, but I was too fiercely independent.

In the long run, it didn't and won't hurt me, but I'll never forget that terrible feeling of being trapped in my job for as long as I owed that 401k money.


jacoavluha

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #16 on: November 28, 2018, 09:32:21 AM »
Some may find this post from The Finance Buff helpful
https://thefinancebuff.com/401k-loan-double-taxation-myth.html

Cheddar Stacker

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #17 on: November 28, 2018, 08:48:10 PM »
Hi Dicey! I dug this up from an old post. Hopefully it makes some sense.

You only pay taxes once, @jacoavluha has the idea here. I only briefly skimmed the other posts. It seems like you pay twice, but you definitely don't.

YOu can project whatever return and all, but on the amount borrowed, you will pay taxes twice:
1) when you pay back the loan
2) when you withdraw in retirement

Am I missing something?

Yeah, I think you're conflating two thoughts here. I've thought about this a lot. I tried to determine if this was a way to get extra funds into your 401k, or pay less tax, or if you end up paying more tax, or whatever. In the end I believe it's all a wash.

Contribution = Deduction.
Loan = Tax free money, just like any other loan.
Repay Loan = Paid with post tax funds, just like any other loan.
Withdrawal = Taxable.

So it looks like you pay taxes twice, but you really don't. You only pay tax on the "deferred" income (initial contribution) once, and that's upon withdrawal. Repayment of the loan is simply a use of net wages. Just like paying your car loan, or buying a car, or buying groceries. It's simply a use of cash, and it's unrelated to the initial contribution to the 401k. So you don't pay taxes twice on the amount borrowed, you pay taxes once on the amount borrowed (when you earn the funds used to repay it) and you pay taxes once on the amount deferred (when you withdrawal it) and they are two completely separate, unrelated transactions.

You will pay taxes (upon withdrawal) on the interest income the loan earned within your 401k, but that's no different than paying tax on the bond interest or dividends/cap gains from your 401k portfolio investments.

Then, you take a loan against the 401k. Let's pretend it's $5k loan at 3% with no other fees (just a nice company who wants you to borrow money) and you borrow it for 1 yr. Let's also assume a lump sum payment on the last day of the year to make things simple. Assuming you're still in the 25% effective tax rate, you will have to earn another $6,666 in order to pay back the $5k loan plus interest (5k / (1-.25)) + 5k x .03 = 6,816 (amount to earn in order to pay back your loan and then have 5,150 in your 401k returned (5k plus 3% interest to yourself).

This example is no different than any other transaction in life. When you go out to a restaurant and buy a $10 entrée, it really costs about $17.50. $10 + $1 sales tax + $2 tip = $13. $13 / (1-.25) = $17.33. So a $10 meal costs about $17.33. It's like the Triple Value of Income concept or this quote below from gocurrycracker's never pay taxes again post:

Quote
A typical middle class family man in the United States goes out for dinner with his wife at one of the nation’s many fine fast food establishments, paying $20 for a couple super sized mechanically separated chicken sandwiches, oily, starchy, and salty side dishes, insulin-bomb sodas, and artificially flavored and colored desserts.  Ignoring the long term health costs of such a decision, how much does Joe Average pay for this meal?  $20?  More like $33.50

Joe Average paid for his meal with after tax dollars.  Assuming a 25% marginal tax rate, social security and medicare taxes (both individual and employer), Joe had to earn $33.50 in order to have a $20 bill in his wallet to pay for that meal, paying $13.50 in tax before even walking into the restaurant.  Including a 10% sales tax already included in the $20 total check, $15.50 was paid in tax.  If they drove to the restaurant, they even paid tax on gas

For the same $33.50 in food spending (there is no sales tax on groceries in Washington State), we enjoyed a couple organic salads, grass-fed steaks, a side of vegetables with garlic and bacon, a couple glasses of wine, and had $10 left over.

It makes sense to me, but then again, I've spent a lot of time considering it, and I do taxes for a damn living, so there's that.

Now, back into obscurity and inactiveness for me. Peace!

lowroller4111

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #18 on: November 29, 2018, 05:05:07 AM »
You are getting confused.. you don't return $13k but you just return the original $10k that you earlier recieved tax free!

Think of it without the tax picture for a moment, you get $10k, you put back $10k.. that's it.

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MDM

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Re: How to withdraw from 401K without penalty/or taxes?
« Reply #19 on: November 29, 2018, 01:37:41 PM »
Some may find this post from The Finance Buff helpful
https://thefinancebuff.com/401k-loan-double-taxation-myth.html
Thanks.  As Double Taxation and the Real Reasons 401(k) Loans Are Bad — My Money Blog (linked within the finance buff's article) notes, one does pay "double taxation" on the interest portion.  See that article for one example.  Here's another:

Assume
  • Tax rate = 20%
  • Investment return = 0%
  • Loan interest rate = 10%
  • No penalty on 401k withdrawal
  • Starting balances of $10K in a 401k and $12K in a bank account
  • Person needs $10K needed to buy 1 widget
Option 1: Withdraw all $10K from 401k to buy widget.  Pay $2K tax from bank account.  Result: 1 widget and $10K in the bank.
Option 2: Buy widget with $10K from bank account.  Withdraw all $10K from 401k, pay $2K tax, and deposit remainder in bank.  Result: 1 widget and $10K in the bank.
Option 3: Take $10K 401k loan.  Buy widget.  Repay $11K to 401k from bank.  Withdraw all $11K from 401k, pay $2200 tax, and deposit remainder in bank.  Result: 1 widget and $9800 in the bank.

The amount of extra tax one pays is (Loan interest * tax_rate).  That is the "double taxation" amount.  Note that most of the interest comes back to the person.

If one does not have cash on hand for the widget, the cost of the 401k loan could be compared with the interest one pays for a bank loan, in which all of the interest goes to the bank.

Of course, if one has the luxury of avoiding the widget purchase, doing so renders all this moot. ;)