A 401(k) plan can help you build wealth for retirement while enjoying some significant tax benefits. You might assume that your retirement assets are untouchable, but that’s not always true. For instance, can the IRS take your 401(k)? You might be surprised to learn that the answer is yes. There are certain situations in which the federal government can lay claim to your retirement funds.
For help making sure you don’t end up in trouble with the IRS, consider working with a financial advisor.
When Can the IRS Take Your 401(k)?
The Internal Revenue Code grants fairly broad powers to the IRS when it comes to retirement account garnishments. Specifically, the IRS has the right to levy or garnish your 401(k) to collect monies owed toward unpaid tax obligations.
What does that mean in simple terms?
Just that, if you don’t pay your federal taxes the IRS can seize your 401(k) to cover what’s due. In addition to a 401(k) plan, the IRS can also garnish other types of retirement accounts for back taxes, including:
- Pensions
- Traditional and Roth IRAs
- SEP and SIMPLE IRAs
- Solo 401(k) plans if you’re self-employed
- 403(b) plans
- Profit-sharing plans
- Eligible deferred compensation plans
Can the IRS take everything in your 401(k) to pay back taxes? Generally, no. The IRS can only garnish amounts that you’re eligible to withdraw.
It’s also important to keep in mind that a 401(k) garnishment is typically a last resort option to get taxpayers to settle up on their tax debts. IRS rules are designed to give taxpayers a chance to pay what’s owed first before their 401(k) plans are attached.
Can the IRS Take Your 401(k) for Other Reasons?
Failing to pay taxes could trigger a 401(k) garnishment but that isn’t the only reason the IRS may seize retirement assets. You could also see your 401(k) drained to pay penalties or fines if you’re convicted of a federal crime.
IRS rules also allow 401(k) funds to be withdrawn when a qualified domestic relations order (QDRO) is issued. While this isn’t a direct garnishment by the IRS, it allows a court to require you to withdraw money from your retirement account when dividing assets in a divorce.
One situation you may be wondering about is student loans. Generally, the IRS cannot take money from your 401(k) in order to pay off student loans. If you default on federal student loan debt, the IRS cannot require you to hand over money from your 401(k) to pay what’s owed. The IRS can, however, offset your tax refund to pay student loan debts or freeze your bank account in an attempt to get you to pay.
How 401(k) Garnishment Works
Before the IRS can garnish a 401(k) for unpaid taxes there’s a certain process that must be completed. Specifically, three things have to happen:
- You receive a tax bill from the IRS.
- You allow that bill to go unpaid.
- The IRS issues a Final Notice of Intent to Levy and a Notice of Your Rights to a Hearing.
The IRS has to give you time to respond to the Final Notice of Levy and request a hearing. Under federal tax rules, you have 30 days to do so.
There are a few exceptions that allow the IRS to forego the 30-day waiting period. For example, if the IRS believes that you might attempt to move assets to evade paying what’s owed, then they could execute the garnishment right away.
If you receive a levy notice, it’s important that you respond to it as quickly as possible. Otherwise, you could be leaving your retirement assets open to seizure by the IRS. The good news is that a couple of situations might allow you to avoid garnishment, even if you owe back taxes.
For example, if a 401(k) levy would cause you undue financial hardship, then the IRS can’t proceed with taking your retirement assets. You would, of course, need to be able to provide documentation to the IRS to support your claim. Likewise, you could avoid a garnishment if you’re in the process of working out an arrangement to pay.
Avoiding 401(k) Garnishment for Unpaid Taxes
The best way to avoid having the IRS take your 401(k) is to pay your taxes at the time that they’re due. Generally, that’s April 15of each year, though the annual tax filing deadline is sometimes adjusted to account for weekends or federal holidays.
Keep in mind that filing a tax extension can give you more time get your return in. However, interest and penalties will accrue on the amount owed until you pay your tax bill in full. If you don’t have cash on hand to pay, you might consider:
- Paying with a credit card
- Taking out a small personal loan to pay the debt
- Withdrawing money from an IRA to pay
- Taking out a 401(k) loan
Each one has pros and cons, but the upside of all four is that they allow you to sidestep owing money to the IRS. If you’re not able to pursue any of those possibilities or you’re well past the deadline for paying your tax bill, there are two other possibilities you might consider.
The first is an Installment Agreement. The IRS allows eligible taxpayers to set up a payment plan to manage back tax debts. You’ll pay a one-time setup fee and interest, but the interest rate is exceptionally low. As long as you make your monthly payments on time, the IRS would have no reason to move ahead with a 401(k) levy.
An Offer in Compromise is the other option. An Offer in Compromise allows you to settle outstanding tax debt for less than what’s owed. It’s less common for the IRS to accept an Offer in Compromise vs. an Installment Agreement. However, it may be worth applying for one if you have cash on hand to pay some of your tax debt.
Talking to a tax professional or your financial advisor can help you figure out the best way to handle unpaid taxes. An accountant or advisor may also be able to guide you on how to maximize breaks in order to minimize what you owe, reducing the possibility of ending up with another tax bill that you’re unable to pay.
The Bottom Line
Protecting your 401(k) is important for securing your retirement future. If you allow federal tax debts to go unpaid, you risk losing some of the money you’ve worked so hard to save to the IRS. Knowing when the IRS can levy your 401(k)—and how to avoid that scenario—can help you preserve your savings until you’re ready to retire.
Retirement Planning Tips
- Consider talking to your financial advisor about how to manage federal tax debts and what rights you have with regard to your 401(k) garnishment. Finding a qualified financial advisor doesn’t have to be hard.SmartAsset’s free toolmatches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals,get started now.
- Opening an IRA can be a smart way to supplement the money you’re saving for retirement through a 401(k) plan at work. A traditional IRA can allow for tax-deductible contributions, while Roth IRAs give you the benefit of tax-free withdrawals when you retire. If you’re interested in opening an IRA, you can do so through an online brokerage. When comparing IRA options, consider the fees you might pay, and the range of investment options offered.
Photo credit: ©iStock.com/Perawit Boonchu,©iStock.com/Perawit Boonchu,©iStock.com/alfexe
Certainly! This article covers a range of concepts related to 401(k) plans, IRS actions, retirement savings, tax implications, and strategies for handling tax debts. Here's a breakdown:
Concepts Covered:
-
401(k) Plans: These are retirement savings accounts offered by employers, allowing employees to save for retirement with tax advantages.
-
Tax Benefits of 401(k)s: Contributions to a 401(k) are usually tax-deferred, meaning they are not taxed until withdrawn during retirement.
-
IRS Actions on 401(k) for Unpaid Taxes: The IRS can garnish or levy a 401(k) to collect unpaid federal taxes.
-
IRS Power over Retirement Accounts: Apart from 401(k)s, the IRS can also garnish other retirement accounts, including IRAs, pensions, and other plans, to collect back taxes.
-
Limits on IRS Garnishment: The IRS can only garnish eligible withdrawal amounts from a 401(k) to cover unpaid taxes.
-
Reasons for IRS Garnishment Beyond Taxes: Besides unpaid taxes, the IRS can seize retirement assets for penalties or fines related to federal crimes.
-
Exceptions to 401(k) Garnishment: Instances where garnishment might be avoided, such as proving undue financial hardship or working on payment arrangements.
-
IRS Processes for Garnishment: The IRS must follow a specific process, including sending notices and allowing time for response before garnishing a 401(k).
-
Avoiding 401(k) Garnishment: Strategies to prevent IRS action, including timely tax payments, extensions, alternative payment methods, Installment Agreements, and Offers in Compromise.
-
Seeking Professional Help: Advising readers to consult tax professionals or financial advisors for managing tax debts and understanding rights regarding 401(k) garnishment.
-
Retirement Planning Tips: Suggestions to discuss tax debts and 401(k) protection with financial advisors, and the recommendation to open IRAs to supplement 401(k) savings.
Relevant Financial Concepts:
-
Tax-Advantaged Accounts: Highlighted various retirement accounts with tax benefits, including Traditional and Roth IRAs, pensions, and 401(k)s.
-
Tax Debt Management: Discussed options like Installment Agreements, Offers in Compromise, and timely payments to handle unpaid taxes.
-
Retirement Planning Strategies: Emphasized the importance of protecting retirement savings and seeking professional advice for financial planning.
This article essentially navigates the landscape of IRS actions, tax implications, and prudent strategies for safeguarding retirement savings. If you have any specific questions or need further insights into these concepts, feel free to ask!
