Can the IRS Take Your 401(k)?

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)? The IRS can levy retirement accounts, including 401(k)s, to collect certain unpaid federal tax debts. However, special IRS procedures apply before retirement assets are generally targeted.

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 collecting delinquent federal taxes. A levy is a legal seizure of property to satisfy a tax debt and retirement accounts are among the assets the IRS may levy.

What does that mean in simple terms?

If you have an unpaid federal tax liability and the IRS completes the required collection procedures, it may levy your 401(k). In addition to a 401(k) plan, retirement arrangements that generally are not exempt from federal tax levies include:

• Qualified pension, profit-sharing and stock bonus plans
• Traditional and Roth IRAs
• SEP IRAs and other qualifying self-employed retirement plans
• 403(b) plans
• Certain eligible 457(b) deferred compensation plans

The amount the IRS can actually collect from a 401(k) depends partly on your rights under the plan. A levy can attach to a vested present right, but it does not force a plan to make funds available before you otherwise have a right to receive them. If the plan does not currently permit you to take a lump-sum distribution, the IRS generally must wait until benefits become payable under the plan before collecting the attached amount.

IRS procedures also give retirement assets additional consideration because those funds are intended to support the taxpayer in the future. Before levying a retirement account, the IRS generally considers other available assets and collection alternatives. It also evaluates whether the taxpayer depends on the retirement money, or will depend on it in the near future, for necessary living expenses.

Can the IRS Take Your 401(k) for Other Reasons?

The IRS levy authority discussed here specifically concerns collection of federal tax liabilities. Other legal processes can affect a 401(k), but they should not be confused with an IRS levy.

For example, a qualified domestic relations order (QDRO) can assign some or all of a participant’s retirement plan benefits to an alternate payee, such as a spouse, former spouse, child or other dependent. A QDRO is a domestic relations order governed by federal retirement plan rules, not an IRS seizure of the account.

Federal criminal judgments can also involve collection remedies, but those rules are separate from the IRS process for levying a 401(k) to satisfy unpaid taxes.

One situation you may be wondering about is student loans. Federal student loan collection rules are also separate from the IRS’ authority to levy property for unpaid federal taxes. A delinquent student loan does not, by itself, give the IRS authority to levy your 401(k) as a tax collection action.

How a 401(k) Levy Works

Before the IRS can typically levy a 401(k) for unpaid federal taxes, it must go through a collection process. This generally includes:

• Assessing the tax and notifying you of the amount due.
• Giving you an opportunity to pay the outstanding balance.
• Sending a final notice stating its intent to levy and informing you of your hearing rights.
• Waiting at least 30 days after issuing the final levy notice before proceeding, subject to limited exceptions.

During that 30-day period, you generally have the right to request a Collection Due Process hearing. Certain circumstances can allow the IRS to proceed without following the usual advance-notice timeline.

Receiving a levy notice means the collection process has reached a stage where prompt action can preserve options for addressing the tax debt before the IRS proceeds against available assets. Depending on your circumstances, those options may include an installment agreement, an offer in compromise or a temporary delay in collection if paying the debt would create financial hardship.

Retirement accounts also receive additional consideration before a levy. The IRS generally looks at whether the liability can be collected from other assets or through another payment arrangement. It also considers whether you rely on the retirement funds, or will need them in the near future, to pay necessary living expenses.

What Happens to Taxes and Penalties When the IRS Levies a 401(k)?

An IRS levy can create a second tax issue because taking money from a 401(k) may itself result in taxable income. The tax consequences depend on the type of retirement account, the character of the funds and the circumstances surrounding the distribution.

Federal tax law provides an exception to the 10% additional tax on certain early retirement plan distributions when the distribution is made because of an IRS levy under Section 6331. That exception applies to the additional early-distribution tax, not to ordinary income tax that may otherwise be due on a taxable distribution.

This distinction can be important when estimating how much of a retirement balance will ultimately remain available to satisfy a tax liability. The account balance, amount subject to levy and tax treatment of the resulting distribution are separate considerations.

Avoiding a 401(k) Levy 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 15 of 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 to file your return, but it does not extend the deadline for paying the tax you owe. Interest generally begins accruing on unpaid tax from the original due date and applicable penalties may also apply.

If you cannot pay the entire balance, paying what you can and exploring an IRS collection alternative may be preferable to withdrawing retirement savings or taking on additional debt solely to pay the bill. The IRS offers several options depending on your circumstances.

The first is an installment agreement, which allows qualifying taxpayers to pay their tax debt over time. Setup fees may apply and interest and applicable penalties generally continue until the balance is paid.

An offer in compromise is another option. It allows you to settle outstanding tax debt for less than what’s owed if you qualify. The IRS considers factors including your ability to pay, income, expenses and asset equity. Taxpayers who can fully pay their liabilities generally will not qualify.

If paying the debt would prevent you from meeting basic living expenses, you may also be able to request a temporary delay in collection. Penalties and interest can continue to accrue while collection is delayed.

Bottom Line

Protecting your 401(k) is important for securing your retirement future. Although federal law gives the IRS authority to levy retirement assets for unpaid taxes, a 401(k) levy is subject to collection procedures and special considerations for retirement accounts. The IRS generally considers other assets, payment arrangements and whether you need the retirement funds for necessary living expenses before levying the account. Responding to IRS notices early can give you more opportunities to resolve the debt before your retirement savings are affected.

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 tool matches you with 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.