So, I was having lunch with a friend last week and she mentioned that she had taken a loan from her 401K. She asked me, as her Tax Specialist, how much was she going to be penalized come tax time. That was a question that I’m sure many of you have had as well.
Rest assured the money that you take out of your employer-sponsored 401K plan or Retirement Savings Plan as a loan during the year need not be filed on your income tax. Why not? Well, this money is viewed as a loan and since you will be repaying it is not viewed as a disbursement. You are in a sense borrowing from the future you. You will not receive a 1099 form on this at the end of the year.
Well, what if I took out a withdrawal? Well, a withdrawal is different. It is allowed once a year (for specific emergency situations) and does not need to be paid back. When electing to receive a withdrawal you are given the option to take a percentage out for taxes. If you choose not to take taxes out, or do not take enough out for taxes you will need to pay tax on this money. In addition, you will be charged a penalty for taking a disbursement before your retirement age and the money that was disbursed come tax time will be taxed at a different rate than your wages. You should receive a 1099-R form from the program sponsor and this form should be given to your Tax Specialist, along with your other tax documents (i.e. W-2’s, receipts, etc.).
Finally, I told my friend that if she really needed to take money out of her retirement plan, it is always best to take a loan over a disbursement.
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