Should I liquidate my 401(k) to pay my husband's back taxes?

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for CreditCards.com, and also wrote for MSN Money, Interest.com and Bankrate.com, and has guested on Martha Stewart Radio and other programs.

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Question Dear To Her Credit,
My husband and I owe over $20,000 in back taxes to the Internal Revenue Service. He owed them some of the money even before we married, and that was 28 years ago. He has been working with our accountant on an offer in compromise. I have two 401(k) plans, which have only $18,000 between them.

My husband needs major dental work, and I have some credit card debt. Our tax guy says I should liquidate my 401(k) plans to pay for the dental work and credit card debt, and use the rest for the offer in compromise with the IRS. I've only been at this company for almost two years so I'm not sure I can take money from one of the 401(k) plans.

Because of our tax debt, we can’t have a home in our name or anything. My husband promises that if I liquidate my retirement plan, he’ll pay me back and put the money back in a savings account for me.

Do you think this is the only way to do this? We really need to get right with the IRS.  – Dorie

Answer

Dear Dorie,
I hate the thought of your carefully saved retirement plan being liquidated at all, let alone mostly for your husband’s debts and expenses. Besides, if you’ve been married 28 years, you are past the age when it’s a good idea for you to lose your retirement nest egg and start over. This is not good.

I can’t give you specific tax advice for this situation, but I can tell you what answers you must find – before you touch your retirement account or file an offer in compromise. (An offer in compromise is used to settle tax debt with the IRS. It allows you to settle your tax liabilities with the Internal Revenue Service for less than the full amount owed.)

First, how much of the tax debt is yours, and how much is your husband’s? Being married doesn’t mean you are liable for all his debt, especially tax debts from before your marriage. You are not required to use your retirement accounts to pay for his back taxes. For tax debt that belongs only to your husband, he must file a separate OIC. You would only file a joint OIC for joint tax debts.

Second, has all or part of the tax debt passed the statute of limitations? The statute of limitations on federal income tax is 10 years. The IRS has that long to try to collect on back taxes, and no more. Under some circumstances, the statute of limitations may be suspended temporarily. In addition, the statute of limitations does not apply when the taxpayer willfully tries to evade taxes, files a false return, or fails to file. In most cases, however, I would question whether any tax debt from over 28 years ago is collectible.

Third question: Can you really take the funds from your 401(k) plan? If you can’t, that’s actually a good thing. Although assets you can withdraw from a retirement account are considered available to pay taxes (reduced by early withdrawal penalties and income taxes), any assets you cannot withdraw yet are protected.

Fourth and final question: Can you purchase a house in your name only? If the tax debts belong to your husband, and if you qualify for the loan yourself, you may be able to at least move on with that part of your life. You can then deal with taxes as a separate issue.

I recommend you tell your husband and the tax guy that you do not want to withdraw from your 401(k) plan to pay for dental work or credit card debt. That’s not what retirement plans are for. When people use their retirement plans for every expense or shortfall that comes along, they’re likely to end up with nothing when they reach retirement age.

Be sure to get qualified, professional tax advice before you, your husband or both of you take as drastic a step as filing an OIC. Tax problem resolution is a specialized field, and not every tax guy can give you the best advice. If your husband has few or no assets, and most of the tax debt belongs to him and is still collectible, filing an OIC may help him resolve the debts.

If the debts are owed by both of you, however, and your balance is almost as much as you owe in taxes, filing an OIC may not give you much benefit. You and your husband may be better off making payments to the IRS, instead. Making payments isn’t an instant solution, but the best solutions seldom are.

Keep a lid on your 401(k) plan if at all possible, and try to make regular contributions every year. Don’t trade your future retirement plans for a one-time quick “fix” for old debts owed to the IRS.

See related: Withdrawing vs. borrowing from 401(k) to pay credit card debt, Near retirement age is the worst time to raid 401(k)

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Updated: 11-17-2017