Using 401k funds to pay down debt, tax bracket concerns. R A. Miller

[getToit11]

We want to use 401k funds to draw down a home equity line of credit balance. We're concerned that in doing so we will place ourselves in a higher tax bracket. Won't those 401k funds we withdraw to pay debts be counted as income, thus placing us in a higher tax bracket? Our current tax rate is 5.75 percent. Appreciate any advice you can offer.

Thanks,

Long-time Turbo Tax customer 

[xmasbaby0]

If you are younger than 59 1/2 you will be subject to a 10% early withdrawal penalty for using funds from your 401k, and you will pay ordinary income tax on that money as well---so yes, you may end up in a higher tax bracket, depending on how much money you take out of the retirement account.  Using the money from a 401k to pay toward a home equity loan is not an exception to the early withdrawal penalty.

[getToit11]

Thanks for your prompt reply to my query. One follow-up question: My wife & I file our taxes jointly. How do I determine our tax bracket so any extra home equity loan payments we make won't bump us into a higher tax bracket? Last question, I swear!

Thanks alot,

Tony

[Opus 17]

---

@getToit11 wrote:

Thanks for your prompt reply to my query. One follow-up question: My wife & I file our taxes jointly. How do I determine our tax bracket so any extra home equity loan payments we make won't bump us into a higher tax bracket? Last question, I swear!

Thanks alot,

Tony

---

You can use this, although the numbers are slightly off because it uses 2023 calculations.

TaxCaster tax calculator

The tax brackets are here.

https://taxfoundation.org/data/all/federal/2024-tax-brackets/

For married filing jointly, your first major threshold is $94,000 of taxable income (after accounting for the standard or itemized deductions).  It's 12% below that and 22% above that.  After that you can go all the way up to $383,000 and pay either 22% or 24%, not that big a difference.

Just be aware that if you are under age 59-1/2, your minimum tax will be 22%, all the way to possibly 42% depending on your income and state tax rates.  And you lose all the future growth potential.  The only reason to even think about paying off a HELOC with 401k funds under age 59-1/2 is if your interest rate is higher than your investment returns.  Even over age 59-1/2 where you won't pay the penalty, you still pay income tax, and it doesn't make sense to pay off the HELOC unless the interest rate is higher than your investment returns in the 401k.