Should You Borrow From Your 401(k) to Pay Off a Tax Bill? Here’s What One Expert Thinks

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It may be an option for you to consider, but it’s not without risk. 

Many people are used to filing a tax return and seeing a refund hit their bank accounts several weeks later. But even if you’ve gotten a refund in the past, you’re not guaranteed to get one every year. And you might even run into a situation where you actually owe the IRS money from the previous tax year.

If that’s not a situation you’re prepared for, though, then you could land in a tough spot. Many people don’t have extra money just sitting around in their savings accounts. If you’re in that boat and you owe the IRS money, you may be on the verge of panic.

But don’t be, says Mark Steber, Chief Tax Information Officer at Jackson Hewitt. While owing money may not be ideal, there are different options you can look at for paying that bill off.

You could, for example, charge it on a credit card, but you might incur costly fees in the process. But if you have a 401(k) plan at work, you may be able to take out a 401(k) loan to cover your tax liability. Steber says this is an option you can certainly look at — but it may not be your best one.

Could a 401(k) loan bail you out when you owe the IRS money?

Many 401(k) plans let you borrow money against your balance for different purposes. And yours might allow you to take out a loan to pay off a tax bill.

It’s easy to see why this option might look appealing. With a 401(k) loan, you’re not paying back a lender. You’re paying yourself back. And that way, you can potentially cover your IRS liability in full without incurring penalties for being late with your tax payment.

But while taking out a 401(k) loan to cover a tax bill is an option you may want to consider, it can also be a risky one. If you end up separating from the employer who sponsors your 401(k) plan, whether due to quitting or being laid off, you might, depending on your plan, have only a few months at that point to repay your loan (whereas you might normally have years). And if you don’t repay your loan, it will count as an early 401(k) withdrawal. At that point, you’ll be looking at a penalty of 10%.

Of course, this assumes you haven’t yet reached age 59 ½. At that age, you can take a 401(k) withdrawal without penalty. But if you’re younger, it’s important to know this rule.

Also, if you take out a 401(k) loan and don’t repay it, aside from penalties, you’ll have less money in your retirement savings. So you might get hurt either way.

Have a professional walk you through your options

Owing the IRS money can be a stressful situation, especially if you don’t have the cash on hand to pay. But a 401(k) loan is by no means your only option for paying that bill.

“The IRS is a kinder, gentler agency than people think it is,” explains Steber. And if you don’t want to take out a 401(k) loan, you can always get on an installment plan to pay off your tax bill over time. As long as you stick to that plan, you won’t risk having your wages garnished due to an unpaid tax obligation.

In fact, your best bet, says Steber, is to consult a tax professional when you owe money, because they can generally give you good advice on how to tackle that bill. “Any competent tax pro can walk you through your payment options,” he explains, which is all the more reason to work with one, no matter your tax situation.

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