I would like to take money out of my 401k where I no longer work because I need to pay off some debt since I stopped working to have a baby. A home equity loan is not an option for me right now, though that would be the best thing, we already have that. I spoke to a rep, who said I can take the money out and get taxed for it. When does that tax penalty take place? Do they tax it once it comes out, or during the next tax year? Is that a choice? Also, what is the IRS penalty and when does that occur? Thanks much!

Distributions from 401(K) plans , including hardship distributions, are taxable to the participant when they are distributed from the plan.

From the funds there will be withheld 20% Federal Withholding and 10% early distribution penalty.

If you are both 55 and terminated from your companyafter the 10% may not apply to you.

If you are 59 1/2 there is no early withdrawal penalty

If you have un-reimbursed medical costs that are 7.5% of your income and you withdraw the money to pay for them the 10% may not apply to you.

Other than the exceptions above it is 20% federal, 10% early withdrawal penalty.

Shirley

If you take a distribution the plan administrator will automatically withhold 20% for federal income taxes. Of course, this may or may not be the correct amount for you - come next April when you submit your taxes you will include the distribution with your other income and your true tax bracket may be different. You will also have to pay the 10% early withdrawal penalty - this is not withheld when they issue the check, so you will have to pay this yourself with your 2008 Federal income tax. The administrator will send you a 1099-R form next January which is what triggers the IRS to look for you to include both the distribution as income and to pay the 10% penalty with your 2008 tax filing.

If your state has an income tax you will also have to pay state tax on the distribution - the administrator does not withhold from the check so you will have to pay this yourself next April.

What is the interest on this debt? Compare that to what you will lose in tax and penalties and lost investment income by taking the money out of the 401K. If you do the math, you will almost always find its not the smart move to take the money from the 401K.

Just a last minute thought, I don't know where you live, but if you are in an area which has been called as a disaster area you can receive the distribution as a hurricane distribution. If you do this the taxes can spread over a three year period. In additon the distributions are not subject to the 20% withholding tax nor are they subject to the 10% tax penalty.

There are certain relief provisions that the IRS and DOL have established.

DOL website at U.S. Department of Labor -- Hurricane Recovery Assistance (http://www.dol.gov/opa/hurricane-recovery.htm#ebsa)
IRS website at http://www.irs.gov/newsroom/article/o,,id=147085,0o.html
Treasury website http://www.teasury.gov/katrina/

If you live in an area affected by Katrina, Rita or Wilma and part of your debt is due to reconstruction costs you may be eligible for this distribution.

Probably does not affect you, but just in case.

If there is any other way, it will cost you more than it is worth to use the 401K money, so it is probably not the best way to go.

Shirley