Question

Fred's family has fallen on hard times financially due to major medical bills. Fred plans to withdraw the money from his 401(k) to pay off the remaining medical bills. He plans to withdraw $10,000 which is the amount he can deduct as an itemized deduction on his income taxes. Which of the following is true?

a.) Fred will have to pay income taxes and a 10% early withdrawal penalty.
b.) Fred may not withdraw money from his 401(k) for medical bills.
c.) Fred will have to pay income taxes on the withdrawal.
d.) Fred may withdraw the money but he will face a 10% early withdrawal penalty.

Answer 1

Fred will likely have to pay both income taxes and a 10% early withdrawal penalty for taking money out of his 401(k) to pay for medical bills. The 401(k) is designed for retirement savings, and early withdrawal often comes with financial penalties, though specific hardships might waive the penalty.

Step-by-step explanation:

Fred is considering withdrawing $10,000 from his 401(k) plan to pay off medical bills. If he does this, it's likely that he will have to pay both income taxes and a 10% early withdrawal penalty on the amount withdrawn. The reason for this is that 401(k) plans are designed to be long-term retirement savings vehicles. While there are certain hardship withdrawals that may be exempt from penalties, such as if the expenses exceed 7.5% of his adjusted gross income and he meets specific requirements, typically, early withdrawals come with financial drawbacks. This ensures that retirement funds are used for their intended purpose. In some cases, especially when dealing with significant medical expenses, the penalty may be waived. However, one would still be responsible for paying income taxes on the withdrawal. It's important for Fred to understand these potential costs when deciding whether to withdraw funds from his 401(k).