Spokane Man Stunned by $140K Tax Bill After 401(k) Withdrawal — Ramsey Show's Advice

Marty’s Mistake: Withdrawing from 401(k) Led to a $140,000 Tax Bill

Marty from Spokane, Washington, believed he was making a smart move toward debt-free homeownership by using $400,000 from his 401(k) to purchase a house. However, this decision came with an unexpected and costly consequence — a staggering $140,000 tax bill. When Marty recently discovered the financial impact of his withdrawal, he reached out to The Ramsey Show for guidance on how to manage the situation.

“I just recently found out that when I go to file my taxes, I am going to owe roughly $140,000,” Marty explained. “I really don’t want to do a payment plan with the IRS, but I just don’t know the best path forward.”

Marty had assumed that all fees and taxes associated with the withdrawal had already been taken care of. But as it turned out, he was misinformed about the process. He didn’t realize that the full amount would be subject to income tax, leading to a significant liability when filing his taxes.

The Ramsey Show’s Advice on Handling the IRS Debt

The Ramsey Show co-hosts Jade Warshaw and Rachel Cruze provided some clear advice on how Marty could handle the situation. They recommended that he avoid high-risk options such as a home equity line of credit (HELOC) or a credit card. Both options can lead to more financial trouble, especially with high interest rates and the risk of losing his home.

“With HELOCs, the interest rates are sometimes insane,” Cruze warned. “I would not put your home at risk.” She also cautioned against using credit cards, noting that their interest rates can be even higher and more volatile, which could cause the debt to spiral out of control.

Instead, Warshaw and Cruze suggested that Marty use his existing $60,000 in savings to cover part of the tax bill and then take out a personal loan from a bank to pay off the remaining balance. They emphasized the importance of paying the IRS as quickly as possible to avoid further penalties and interest.

“You’re already in the hole,” Cruze said. “Be in the hole with a bank.”

The Consequences of Early 401(k) Withdrawals

Marty’s story serves as a cautionary tale about the risks of tapping into retirement accounts. While it may seem like an easy source of cash, early withdrawals can come with serious consequences.

When you withdraw money from a 401(k) before age 59½, you typically face a 10% early withdrawal penalty plus ordinary income tax on the entire amount. For example, if someone withdraws $20,000, they might owe $2,000 in penalties and $4,400 in taxes, totaling $6,400 in fees and taxes — or 32% of the withdrawal.

In addition to these immediate costs, there are long-term implications. Money withdrawn from a 401(k) is no longer invested, meaning it misses out on potential growth. Over time, this could result in a significant loss of future wealth.

When Is It Okay to Withdraw from a 401(k)?

While early withdrawals are generally discouraged, there are some situations where they may be necessary:

• Avoiding foreclosure or eviction
• Job loss with no savings or access to credit
• Disability or death (penalties may be waived)
• Hardship withdrawals, such as for terminal illness (may be exempt from the 10% penalty, but income taxes still apply)

Before considering a withdrawal, it’s important to explore other options, such as using emergency savings, taking out a personal loan, or selling non-retirement investments.

Final Thoughts

Pulling from a 401(k) early can feel like a quick fix, but it often leads to long-term financial damage. With taxes, penalties, and lost investment growth, individuals can end up losing 30% to 40% of what they take out. It should always be considered a last resort rather than an easy solution.

If you find yourself in a similar situation, it’s crucial to understand the full financial impact and explore alternatives before making any decisions. Working with a financial advisor or expert can help you navigate the complexities and make informed choices.