Can You Really Use 401(k) For Medical Expenses? – Avoid This Mistake + FAQs

Confused about using your 401(k) for medical expenses? You’re not alone. According to NPR and KFF Health News, over 100 million Americans are burdened by health care debt, often forced to make painful choices like draining retirement accounts to pay medical bills.

• ✅ It’s possible, but proceed with caution: You can use a 401(k) for medical costs, but early withdrawals typically incur income tax and a 10% penalty if you’re under 59½ – unless you meet strict IRS exceptions.
• 💡 IRS exceptions exist: Unreimbursed medical bills above 7.5% of your income, total and permanent disability, or leaving your job at age 55+ can waive the 10% penalty. You’ll still owe regular taxes, though.
• 🔄 Consider alternatives first: A 401(k) loan or other funding sources (HSA, payment plans, personal loans) can cover medical bills without permanently reducing your retirement nest egg or triggering hefty tax penalties.
• ⚖️ Weigh the impact: Using retirement funds for current expenses can erode your future financial security. Understand all the rules and consequences before tapping your 401(k) – it should usually be a last resort for medical emergencies.

Yes, you can use money from your 401(k) to pay for medical expenses, but it comes with significant rules, taxes, and potential penalties.

Using a 401(k) for medical bills is allowed under federal law, yet it should be approached carefully because of the impact on both your current finances and future retirement.

What the IRS and Federal Law Say About 401(k)s for Medical Expenses

Under federal law, 401(k) plans are designed for retirement savings, so withdrawing funds early (before age 59½) is discouraged with a 10% penalty.

The IRS does permit earlier access to your 401(k) in certain circumstances, including serious medical needs. However, you must follow specific rules to qualify, and even then, you will likely owe income tax on the amount withdrawn.

In short, it is legal to use your 401(k) for medical expenses, but you need to meet eligibility criteria and understand the tax implications. Below we break down the key federal rules – from what counts as a medical hardship to how taxes and penalties work – and strategies to lessen the financial blow if you take this route.

Hardship Withdrawals for Medical Needs: Eligibility Requirements

A 401(k) hardship withdrawal is a special provision that allows you to take money out for an “immediate and heavy financial need.” Medical expenses not covered by insurance are explicitly considered a valid hardship. This means if you or your spouse, children, or dependents have significant medical bills, your 401(k) plan may allow you to withdraw funds early to pay them.

Not every 401(k) plan permits hardship withdrawals – it’s up to your employer’s plan rules. If allowed, you typically must prove the hardship (e.g. provide hospital bills or a letter). You can generally only withdraw the amount necessary to cover the expense (and potentially the taxes on the withdrawal).

Eligibility often requires that you have no other readily available resources to pay the bills. In practice, this means you’d need to tap your 401(k) as a last resort after using savings or other means.

Remember, a hardship distribution is not a loan – it’s a permanent withdrawal. You don’t pay it back, and your 401(k) balance is permanently reduced. Plans used to require you to stop contributing for 6 months after a hardship withdrawal, but under current rules you can continue contributing (which is good for getting back on track once you’ve overcome the hardship).

Taxes and Early Withdrawal Penalties on 401(k) Medical Use

Any funds you take out of a traditional 401(k) will be subject to federal income tax. Because your contributions were pre-tax, withdrawals are treated as ordinary income in the year you take the money. If you withdraw $20,000 for medical bills, that $20,000 is added to your taxable income for the year.

This could bump you into a higher tax bracket or increase your tax bill significantly. Most plan providers will withhold a portion (often 20%) for taxes, but you are responsible for any additional tax due beyond the withholding.

On top of income tax, the IRS normally imposes a 10% early withdrawal penalty if you’re under 59½. This penalty is essentially a fee for tapping your retirement funds early.

For example, withdrawing that $20,000 could incur a $2,000 penalty payable to the IRS. The penalty is calculated when you file your taxes (using Form 5329 to report exceptions). Unless you qualify for an exception, expect this extra 10% hit.

Important: Even if your 401(k) plan approves a hardship withdrawal, that doesn’t automatically waive the IRS penalty. “Hardship” is a plan administrative concept; the tax penalty is a separate matter governed by the IRS. Many people confuse the two, thinking if the plan allowed it for medical reasons, the penalty won’t apply – which is not true unless you meet a specific IRS exception.

Exceptions That Let You Avoid the 10% Penalty

Thankfully, the tax code provides certain exceptions where the 10% early withdrawal penalty is waived. For medical needs, the most relevant exception is for large unreimbursed medical expenses.

If your out-of-pocket medical expenses in a year are more than 7.5% of your adjusted gross income (AGI), the IRS lets you withdraw from a retirement account penalty-free up to the amount of those expenses above that threshold. In simpler terms, the portion of your withdrawal used for hefty medical bills can avoid the 10% penalty.

For example, suppose your AGI is $50,000 and you have $10,000 in qualified medical expenses not covered by insurance. The threshold is 7.5% of $50,000, which is $3,750. Your expenses above that amount are $6,250. If you withdraw $6,250 from your 401(k) to pay those bills, you would not owe the 10% penalty on that withdrawal. (You’d still owe regular income tax on it.)

However, if you withdrew more than the qualified expense amount, the extra would be penalized. It’s crucial to document your medical expenses and keep receipts in case of an IRS inquiry, though you don’t have to send them in with your tax return.

Another key exception is if you become totally and permanently disabled. The IRS defines disability strictly: you must be unable to engage in any substantial gainful activity due to a physical or mental condition expected to be of long duration or death. If you meet this definition (usually requiring a physician’s certification), any withdrawals from your 401(k) are penalty-free.

For someone who unfortunately becomes disabled by a serious illness or accident, this provision allows access to retirement funds without the 10% penalty as you cope with medical and living expenses. Again, normal taxes apply, but the extra penalty is waived.

There are other penalty exceptions unrelated to medical needs, but they can indirectly help in medical situations. Notably, if you leave your job in or after the year you turn 55 (the “Rule of 55”), withdrawals from that employer’s 401(k) are penalty-free. So if, say, an individual age 56 quits work due to health issues or is laid off, they could use their 401(k) for medical bills without the 10% penalty because of this age-based exception. Similarly, qualified domestic relations orders (QDROs), certain disaster distributions, or a series of substantially equal periodic payments (Section 72(t) schedule) are other routes that avoid the penalty, though those are less common for medical needs.

It’s worth noting that IRAs have some different exceptions (like penalty-free IRA withdrawals to pay health insurance premiums while unemployed, or for higher education). But 401(k) plans generally do not offer those specific exceptions. If you have an IRA, you might compare rules, but for medical expenses, the 7.5% AGI rule and disability are your main potential penalty waivers for both IRAs and 401(k)s.

401(k) Loans vs. Withdrawals: Minimizing the Hit

One strategy to avoid taxes and penalties altogether is to see if your 401(k) plan offers loans. A 401(k) loan lets you borrow money from your own account (typically up to 50% of your vested balance or $50,000, whichever is less) and pay it back over time, usually with interest to yourself. For example, if you have a $40,000 medical bill, you might take a $20,000 loan from your 401(k) rather than a withdrawal.

The advantage is that a loan is not taxable income and no 10% penalty applies, because you’re expected to repay it. You essentially become your own lender. The interest you pay goes back into your account. This can be a much better option if you can afford the loan payments, as it keeps your retirement intact and avoids triggering a tax event. Many people use 401(k) loans for short-term needs to avoid cashing out investments.

However, there are risks and limitations. If you lose your job (or quit) with an outstanding 401(k) loan, you may be required to repay the full balance quickly (by the next tax deadline in many cases). Any unpaid amount would then be treated as a distribution – meaning it becomes taxable and subject to the 10% penalty if you’re under 59½.

So a loan is safest if your employment is stable. Additionally, not all plans allow loans, and if they do, you must follow the repayment schedule (usually via payroll deductions over up to 5 years, unless the loan is for a home purchase).

Aside from loans, smart withdrawal timing can minimize penalties and taxes. If your medical expenses qualify for the exception, try to take out only what you need to cover those bills above the 7.5% threshold. Taking more than necessary just increases your tax burden and penalty exposure. If you’re close to age 59½ or age 55 and separation, consider delaying withdrawal until you hit those milestones, to sidestep the penalty. Every situation is different, but the overarching strategy is to withdraw the smallest amount possible, at the right time, and under the exception rules to reduce extra costs.

State-by-State Tax Differences for 401(k) Medical Withdrawals

Federal rules aren’t the only consideration – your state’s tax laws also affect how much you’ll net from a 401(k) withdrawal for medical expenses. While the 10% early withdrawal penalty is a federal tax, states may impose their own income taxes (and in rare cases, additional penalties) on the distribution. Below is a state-by-state breakdown of how 401(k) withdrawals (including those for medical needs) are treated:

Key takeaways from the table: If you live in a state with no income tax (like Florida, Texas, etc.), your 401(k) withdrawal will only face federal taxes. A few states (Illinois, Mississippi) don’t tax retirement withdrawals at all, which can soften the blow if you must use your 401(k). Many states offer partial exclusions for retirees over certain ages – though if you’re taking an early withdrawal for medical reasons and you’re not yet a retiree, those exclusions usually won’t apply.

California stands out because it tacks on a 2.5% state penalty for early distributions on top of the federal 10%, making early withdrawals extra costly for Californians. Pennsylvania generally exempts retirement income if you retire and meet age requirements, but if you take an early withdrawal for a mid-life medical emergency, Pennsylvania will tax it. The bottom line: be aware of your state’s rules – an early 401(k) withdrawal will almost always be counted as taxable income at the state level, except in no-tax states or those few that exempt retirement distributions. Plan for that in addition to federal taxes.

Alternatives to Using Your 401(k) for Medical Bills

Before raiding your 401(k), it’s wise to explore other ways to cover medical expenses. Your retirement fund should usually be the last line of defense due to the downsides we’ve discussed. Here are some alternatives and how they compare:

• Health Savings Account (HSA): If you have an HSA, tap that first. HSA withdrawals for qualified medical expenses are completely tax-free. This is by far the most cost-effective way to pay medical bills if available. Unlike a 401(k), an HSA is meant for medical costs and has no penalty or tax (for qualified expenses). The only limitation is you can only spend what you’ve saved in the HSA, and not everyone has one.

• Insurance payment plans & assistance: Make sure you’ve exhausted all insurance options. Sometimes procedures or hospital stays have coverage you might not realize, or you can appeal a denial. Hospitals often have financial assistance programs or will negotiate a payment plan at low or zero interest. It’s easier to pay a bill over time than to withdraw from your 401(k) and suffer the tax hit. Many providers would rather receive installment payments than push someone into financial ruin – you just have to ask.

• Personal savings or emergency fund: It’s always best to use after-tax savings for medical costs if you have them, rather than dip into retirement. Using $10,000 from a savings account is a straight $10,000 toward your bills. Taking $10,000 from a 401(k) could shrink to $7,000 or less after taxes and penalties. Of course, not everyone has that kind of savings, but even partial use can reduce how much you need from your 401(k).

• 0% APR credit card or personal loan: In some cases, using a credit card with a 0% introductory rate, or a personal loan, can bridge the gap. This isn’t “free” money – you will have to pay it back – but if you can manage the payments, it might cost less in interest than the effective cost of pulling from a 401(k). For example, a two-year personal loan at a reasonable interest rate might accrue a few hundred dollars in interest, whereas a 401(k) withdrawal could incur thousands in taxes plus the permanent loss of investment growth. Be careful with debt, but it can be a lesser evil compared to raiding retirement.

• Home equity or line of credit: Homeowners sometimes consider a home equity loan/line to cover large medical expenses. Interest rates can be lower than credit cards, and the interest may be tax-deductible as medical debt in some cases. This puts your house on the line, so it’s not to be done lightly. However, it spreads the cost over time. Compare the long-term cost: borrowing against your home might accrue interest, but withdrawing from a 401(k) could cost you much more in lost future value.

• Other retirement accounts (IRA, Roth IRA): If you have a traditional IRA in addition to a 401(k), the rules for penalty exceptions are similar. One advantage of an IRA: if you’re unemployed, you can withdraw from an IRA to pay health insurance premiums without penalty – but this does not apply to 401(k)s. Roth IRAs are a unique case; you can withdraw your contributions (not earnings) anytime tax- and penalty-free. If you have a Roth IRA, you might take out contributions to cover medical costs and leave your 401(k) untouched. This way, you avoid taxes (since contributions were after-tax) and no penalty on those contributions. Be cautious not to dip into Roth earnings, though, if under 59½, as those could be penalized.

• Bankruptcy or hardship programs: This is a drastic step, but it should be mentioned: retirement accounts like a 401(k) are generally protected from creditors and bankruptcy. If your medical bills are catastrophic and you truly cannot pay them, you might qualify for bankruptcy relief or charity care. It may sound extreme, but many medical debts get discharged in bankruptcy while your 401(k) remains intact. It’s worth consulting a financial counselor or attorney before liquidating a retirement account, especially if the medical debt is enormous. You might preserve your retirement and handle the debt through legal means or negotiated settlements. This path has its own consequences (credit impact, etc.), but so does draining your 401(k). The point is to consider every option.

Each of these alternatives has pros and cons, but they share a common theme: they help you avoid the irreversible damage of taking from your 401(k) too soon. In many cases, a combination of strategies – using some savings, negotiating the bill down or onto a payment plan, and perhaps taking a small loan – can cover the need without completely derailing your retirement.

Always compare the long-term cost and seek advice if you’re unsure. Financial planners or credit counselors experienced in medical debt can offer guidance tailored to your situation.

Pros and Cons of Using a 401(k) for Medical Expenses

Is tapping your 401(k) for medical bills a smart lifeline or a costly mistake? It can be a bit of both. Here’s a quick comparison of the advantages and drawbacks:

As you can see, the benefits of using a 401(k) for medical expenses center on immediacy and avoiding new debt – you can get money quickly without having to apply or qualify for financing, and if you meet an IRS exception, you might even avoid the early withdrawal penalty. In a true emergency, that access can be a lifesaver (sometimes literally, if it funds urgent care or surgery).

On the other hand, the downsides are significant. You’re robbing your future self of money and growth that might be very hard to replace. The taxes and penalties act like an expensive “fee” for taking the money now – often 20-30% or more of the withdrawal can vanish in costs. And there are hidden dangers, like the risk of a loan default if your job situation changes. In short, using a 401(k) for medical bills can solve a short-term problem but create a long-term challenge.

Case Law: Lessons from Real 401(k) Medical Withdrawal Cases

Court cases and IRS rulings show that the rules for 401(k) withdrawals are applied strictly, even in sympathetic situations. It’s worth looking at a couple of real examples where people tried to use retirement funds for medical reasons, to understand the limits:

• Using funds for a non-dependent’s medical bills: In a Tax Court case (Ireland v. Comm., 2015), a woman withdrew from her retirement account to pay her adult son’s medical expenses. Her son was seriously ill, but he was not claimed as her dependent. She argued it was a hardship, but the court still upheld the 10% penalty on her withdrawal. The IRS rule is clear that the medical expense penalty exception only covers costs for yourself, your spouse, or your dependents. Helping out a family member who isn’t officially a dependent doesn’t qualify – no matter how valid the need. Lesson: The IRS won’t bend the rules on who counts as a dependent for the medical exception. If you plan to use your 401(k) to pay someone else’s medical bills, make sure that person is your tax dependent or you won’t escape the penalty.

• Claiming disability without meeting the definition: In another case (Lucas v. Comm., 2023), a taxpayer in his 50s took a 401(k) distribution after he lost his job and was dealing with diabetes and health issues. He tried to claim the distribution shouldn’t be penalized because he was “disabled” by his medical condition. While diabetes is serious, he was still able to perform some work, and the Tax Court ruled he did not meet the strict definition of total disability required to waive the penalty. The result: he owed the 10% penalty (and taxes) on the withdrawal. Lesson: Just having a medical condition or hardship isn’t enough to avoid the penalty – you must meet the IRS’s criteria to the letter. Total and permanent disability means you cannot engage in any substantial gainful employment. Partial disabilities or temporary medical issues won’t count for the disability exception.

These cases highlight that good intentions or difficult circumstances alone won’t exempt you from taxes and penalties. The IRS provides certain narrow exceptions, but if your situation falls even slightly outside those lines, the penalties will apply. Always check the exact requirements (for example, who is a “dependent,” or what “disabled” means) before assuming you qualify for a break. If in doubt, consult a tax professional to see if your withdrawal can fit an exception, or to plan a strategy that minimizes the damage.

Avoid These Common Mistakes When Using a 401(k) for Medical Costs

When people decide to tap their 401(k) for medical expenses, they often make mistakes that can cost them even more. Here are some common pitfalls to avoid:

• Assuming “hardship” means tax-free: Many believe that if their 401(k) plan approves a hardship withdrawal for medical reasons, they won’t owe extra taxes or penalties. Wrong. Hardship approval doesn’t waive income tax or the 10% IRS penalty unless you meet a specific exception. Always account for taxes and check if you qualify for a penalty exception – don’t assume the hardship label alone saves you from the IRS.

• Withdrawing more than you absolutely need: It’s tempting to take a little extra “just in case” when accessing your 401(k). Taking out too much is a costly mistake. Every dollar you withdraw will be taxed, and possibly penalized, and will no longer be growing for retirement. Only withdraw the minimum needed to cover the medical bills (and maybe the tax withholding on that withdrawal). Taking, say, $5,000 extra as a cushion could needlessly cost you $500 in penalties and additional taxes, plus lost investment growth.

• Not checking what counts as a qualified expense: To use the medical expense exception, the expense must qualify as deductible medical care under IRS rules and not be reimbursed by insurance. People sometimes assume all medical-related costs count, but things like elective procedures or cosmetic surgery might not qualify. Or they pay a medical bill for a relative thinking it counts, but if that person isn’t a dependent, it doesn’t. Ensure the expense is eligible – refer to IRS Publication 502 for what is considered a medical expense. If you claim an exception that you’re not entitled to, the IRS can disallow it and impose penalties and interest later.

• Overlooking the 7.5% AGI threshold calculation: If you plan to avoid the 10% penalty using the medical expense rule, remember it only applies to expenses above 7.5% of your income. A common mistake is not realizing how that works. For example, if your AGI is $100k with $8k of medical bills, only expenses over $7.5k count – so $500 of that qualifies. If you withdrew the full $8k from your 401(k), $7.5k of it would still be subject to penalty. Know your AGI and do the math first. You might need to limit the withdrawal to the qualifying portion or be prepared for some penalty.

• Ignoring 401(k) loan options or other resources: Some folks immediately take a hardship withdrawal without checking if a loan was possible, or before exploring outside help. This is a mistake that can unnecessarily trigger taxes and penalties. Always check if your plan’s loan option can cover the need. Also, look into things like hospital financial assistance or charity care, crowdsourcing, family help, anything, before you pull the retirement ripcord. Hardship withdrawals should be the last resort. Exhaust the no-penalty, lower-cost options first.

• Forgetting the tax implications at filing time: When you withdraw from a 401(k), you may get a big tax surprise if you don’t plan. Your plan might withhold 10% or 20% for federal tax, which may not be enough. Plus, state taxes might not have been withheld at all. One mistake is not setting aside part of the withdrawal to cover the tax bill, or not adjusting your withholdings. Come April, you don’t want to find out you owe a few thousand in taxes because of that withdrawal. Work through a tax projection when you withdraw, and consider having extra tax withheld up front to avoid an unpleasant bill later.

Avoiding these mistakes can save you a lot of financial pain. The overarching theme is do your homework: know the rules, plan for the taxes, double-check eligibility for exceptions, and be sparing with how much you withdraw. Using a 401(k) for medical expenses is already a tough decision – don’t compound it with an avoidable error.

FAQs

Q: Can I withdraw from my 401(k) for medical bills without paying the 10% penalty?
A: Yes, but only if you meet specific IRS exceptions. For example, if your unreimbursed medical expenses exceed 7.5% of your income, the amount above that threshold can be withdrawn penalty-free (taxes still apply).

Q: What qualifies as a medical hardship for a 401(k) withdrawal?
A: Generally, expenses for diagnosing, treating, or preventing disease for you, your spouse, or dependents that aren’t covered by insurance. These create an “immediate and heavy” financial need allowing a plan hardship withdrawal.

Q: Do I have to pay taxes if I use my 401(k) for medical expenses?
A: Yes. Any withdrawal from a traditional 401(k) is subject to federal (and possibly state) income tax, even if you qualify to avoid the 10% early withdrawal penalty.

Q: Is it better to take a 401(k) loan or a hardship withdrawal for medical costs?
A: A loan is often better if you can repay it, because it avoids taxes and penalties. You pay yourself back with interest. A hardship withdrawal incurs taxes and possibly penalties and permanently reduces your savings.

Q: How do I prove to the IRS that my 401(k) withdrawal was for medical expenses?
A: You don’t send receipts with your tax return, but you must file Form 5329 and indicate the exception. Keep documentation (bills, payment records) in case of an audit to show the expenses exceeded 7.5% of your AGI and who they were for.

Q: Can creditors or hospitals go after my 401(k) if I don’t pay medical bills?
A: No, 401(k) assets are generally protected from creditors and lawsuits. Hospitals can sue for the debt, but they cannot seize your 401(k) savings. This protection is why you should think carefully before voluntarily cashing out your 401(k).

Q: Should I cash out my 401(k) or consider bankruptcy for huge medical debt?
A: Tapping your 401(k) is typically a last resort. If medical debt is overwhelming, bankruptcy might discharge the debt while your 401(k) stays intact. It’s a serious decision – consult a professional for personalized advice.

Q: Will my 401(k) hardship withdrawal for medical bills affect my credit score?
A: The withdrawal itself doesn’t impact your credit (it’s not a loan or default). However, if taking the money prevents you from missing bill payments or incurring debt, it could indirectly help your credit by avoiding those negatives.

Q: Can I use my 401(k) to pay medical insurance premiums if I’m out of work?
A: Not directly through a 401(k) exception. However, if you roll the funds into an IRA, IRA rules allow penalty-free withdrawals to pay health insurance premiums while unemployed. 401(k)s don’t have a specific penalty exemption for insurance premiums.

Q: If I take a hardship withdrawal for medical bills, can I contribute to my 401(k) later?
A: Yes. In fact, current rules encourage you to keep contributing – there is no longer a 6-month mandatory suspension of contributions after a hardship withdrawal. Resume contributions as soon as you’re able to rebuild your savings.