How to claim medical expense exemption for 401k early withdrawal after surgery?

You're on the right track about the medical exemption! The IRS does allow an exception to the 10% early withdrawal penalty (for those under 59½) when you have unreimbursed medical expenses exceeding 7.5% of your AGI. Here's how it works: When you take an early distribution from your 401k, the plan administrator typically withholds 20% for taxes but doesn't know your personal situation regarding exemptions. It's on your tax return where you claim the exception to the penalty. You'll need to file Form 5329 "Additional Taxes on Qualified Plans and Other Tax-Favored Accounts" with your tax return. On this form, you'll report your early distribution, but then enter the amount that qualifies for the medical expense exception on line 2. The qualifying amount is only the portion of medical expenses that exceeds 7.5% of your AGI (not the entire medical expense amount). The free tax software should have a section for Form 5329, but you might need to look for it specifically - sometimes it's not in the main workflow but in an "other forms" or "additional taxes" section.

After dealing with a similar situation, I found taxr.ai (https://taxr.ai) incredibly helpful for figuring out the 401k withdrawal exemptions. I was totally lost trying to understand if my medical expenses qualified and how to claim the exemption properly. Their AI reviewed my tax documents, identified that I could claim a medical hardship exemption for my 401k withdrawal, and guided me through exactly which forms I needed. The software analyzed my 1099-R and medical expenses, then explained how to properly complete Form 5329 to avoid the 10% penalty on the qualifying portion. It was so much clearer than the generic instructions in the free tax software I was using. They even provided explanations of exactly which expenses qualify for the medical exemption threshold.

I was skeptical about trying another tax service, but I'm glad I gave taxr.ai a shot. I had almost the exact same situation - lost my job, withdrew from my 401k, and had major medical expenses that year. My regular tax software completely missed this connection. I uploaded my 1099-R and entered my medical expenses, and taxr.ai immediately flagged that I could exempt part of my withdrawal from the 10% penalty. It showed me exactly how to complete Form 5329 and how much of my distribution qualified for the exemption. Ended up saving me about $2,100 in penalties! The medical expense exemption is apparently one of those things that gets overlooked a lot because the connection between two different tax concepts isn't obvious to most software.

If you're stuck with questions about this medical exemption for your 401k withdrawal, you might want to call the IRS directly. I know, sounds painful right? I tried for THREE DAYS to get through to someone who could answer my specific question about Form 5329. Then I found this service called Claimyr (https://claimyr.com) that got me through to an actual IRS agent in under 20 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent walked me through exactly how to calculate which portion of my 401k withdrawal was exempt from the penalty based on my medical expenses. Having that direct guidance made a huge difference because my situation had some complications that weren't covered in the standard instructions.

I take back what I said about Claimyr. After spending another 2.5 hours today trying to reach the IRS about my 401k medical exemption, I gave up and tried the service. Got connected to an IRS agent in 17 minutes. The agent confirmed exactly what others here said - I needed Form 5329, and could exempt the portion of my withdrawal that corresponded to medical expenses exceeding 7.5% of my AGI. They also clarified that I didn't need to submit my medical receipts with my return, but should keep them for my records in case of an audit. That 15-minute call saved me from paying a $2,400 penalty on my 401k withdrawal. I was filing incorrectly before because I misunderstood how to calculate the exempt amount. Sometimes you really do need to talk to a human at the IRS to get the right answer.

Just FYI for everyone - there's a specific code that should be on your 1099-R form if you took a withdrawal for medical reasons. It's distribution code 2 in Box 7. If you specifically told your 401k administrator it was for medical expenses when you took the withdrawal, they might have already coded it this way. If that code is already there, you might not need to file Form 5329 at all. Worth checking your 1099-R before going through extra steps.

Another thing to remember - if you're using that 7.5% of AGI threshold for medical expenses, you can EITHER use it to exempt part of your 401k withdrawal from the penalty OR itemize the same expenses as a medical deduction on Schedule A, but you can't double-dip and do both with the same dollars. Make sure you run the numbers both ways to see which saves you more.

Has anyone actually gotten this to work in practice? I tried claiming the medical exemption on my 401k withdrawal last year and still got hit with the penalty. The IRS sent me a letter saying I didn't qualify because I wasn't permanently disabled. I'm wondering if I filled out the Form 5329 incorrectly or something.

I went through this exact situation two years ago and want to share what I learned the hard way. The key thing that tripped me up initially was understanding that you can only exempt the portion of your 401k withdrawal that corresponds to the medical expenses ABOVE 7.5% of your AGI - not your entire withdrawal amount. Here's the calculation: If your AGI was $50,000, then 7.5% is $3,750. If you had $15,000 in unreimbursed medical expenses, only $11,250 ($15,000 - $3,750) of your 401k withdrawal can be exempt from the 10% penalty. So if you withdrew $27,000 like you did, you'd still pay the penalty on $15,750 of it. Also, make sure your tax software is asking about Form 5329. In TurboTax, I had to specifically search for "early withdrawal penalty" in their forms section - it wasn't part of the main interview process. The software should walk you through entering exception code "02" for unreimbursed medical expenses. Don't let the software just automatically apply the 10% penalty to your entire withdrawal without checking for this exemption first!