How to Use a 401(k) to Pay Off an IRS Levy Without a Penalty

Paying off the Internal Revenue Service is likely the last thing you planned on spending your 401(k) plan on. If you've already reached age 59 1/2, you can take your distributions penalty-free whether you're withdrawing to pay off IRS debts or any other reason because it's a qualified distribution. If you're not 59 1/2 years old, you can avoid the penalty only if the IRS specifically levies your 401(k) plan. When the IRS levies your 401(k) plan, it will have your 401(k) plan send the money from the account directly to the IRS, rather than having you take a distribution and then pass along the proceeds. If the IRS just says that you owe money, but doesn't specifically levy your 401(k) plan, the exception doesn't apply.

Step 1

Wait until the IRS takes the money out of your 401(k) to satisfy your tax debt if the IRS has levied your plan. When the IRS levies an account, it will place a hold on it for 21 days to resolve any disputes, after which it will have the plan send the money directly to the IRS.

Step 2

Report the amount of the distribution on your taxes as pension and annuity income. Even if you're taking the distribution to pay the IRS levy, you'll still have to include it on your income taxes. If you're over 59 1/2, you don't have to take any further steps to avoid the early withdrawal penalty.

Step 3

Complete Form 5329 to claim the early withdrawal penalty exception for the IRS levying your 401(k) plan. Next to line 2, write "10" in the space provided to indicate your exception is due to a levy. If you took out the money on your own, the exception doesn't apply and you'll need use Form 5329 to figure your 10 percent penalty.

Items you will need

  • IRS Form 5329

Tip

  • Remember to report any federal income tax withholding from your 401(k) plan withdrawal when you file your income taxes. The amount withheld for federal income taxes is found in box 4 of the Form 1099-R documenting your withdrawal.
  • If the IRS does not levy your 401(k), but does levy other assets that you want to protect, you can request a distribution from your 401(k) plan to pay off the IRS levy, but the exception won't apply. If you're not 59 1/2 years old, you'll need to request a hardship distribution, which requires that you show what the IRS calls an "immediate and heavy financial need." On your withdrawal request form, you'll need to note you need a hardship distribution in addition to providing your name, identifying information, account information and the amount you need to withdraw.

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About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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