For many people, their 401(k) represents their hard-earned savings toward eventual retirement. You may be fortunate enough to have an employer that will match your monthly 401K contributions, allowing your retirement funds to accrue even faster.
What will happen to your nest egg if you’re facing IRS asset seizure or levy for unpaid taxes? The IRS can seize the following in order to satisfy an unpaid tax debt:
- Checking and savings accounts
- Wages, commissions, and other employment-based earnings
- Investments such as CDs, stocks, bonds, IRAs and 401ks.
If the IRS moves to garnish your wages, they don’t need to abide by the same requirements as any other creditor; the IRS doesn’t need to obtain a court order, for example, in order to garnish your wages and commissions.
In most cases, there is a 10 percent penalty for an early 401(k) withdrawal. However, the rules change when the IRS levies the account themselves in order to satisfy an outstanding tax debt.
- You will not be liable for the 10 percent early withdrawal penalty; the IRS will levy the account and instruct your 401(k) plan administrator to transfer the funds directly to the IRS. Generally, the funds will be placed on hold for 21 days to resolve any disputes.
- You will need to fill out Form 5329 to claim exemption from the 10 percent early withdrawal penalty. Each reason for withdrawal is assigned a numerical code. In this case, you will place a “10” in the space provided to indicate the early withdrawal was due to an IRS levy.
However, if you are younger than 59 1/2 and you withdrew the funds yourself to satisfy the levy, you will be subject to the 10 percent early withdrawal penalty, plus any state and federal taxes on the dollar amount withdrawn, since it is considered income.
If you are 59 1/2 or older, you can take a 401(k) distribution without penalty.
In some cases, you can request a “hardship distribution” from your 401(k) administrator. Suppose the IRS will be levying other assets you want to protect. You can request a full or partial distribution from your 401(k) plan to pay off the levy. The hardship distribution option allows you to state the reason for early distribution or withdrawal and “immediate and heavy financial need” according to the IRS.
By understanding the rules governing a 401(k) levy, you’ll be in a better position to assess whether or not you’ll need a tax pro to guide you through the process of determining your best options and understanding your rights.
If you’re facing an IRS levy or other tough tax matter, we have qualified tax pros on staff to help you. Get started today by clicking the white “Start Chat” button at the top of any of our webpages, or give us a call at (888) 224-3004.