Should I use the 401k?

I'm 28 years old and my wife and I are adopting. We will get a tax credit for the adoption. The adoption has put us into substantial debt. From a previous job I have a 401K with about 16,000. I'm tempted to cash that in to put towards the debt, will the adoption tax credit help so I don't take a gigantic beating on penalties and taxes?

Thanks

Ben76,

Good for you and your wife for adopting a child.

Have you asked your friends, relatives and your Church family to help with some of the adoption expenses? Don't be shy.

You will likely qualify for the the adoption tax credit. This reduces the the tax that is due from your income, including the money you take from the 401k account. If you do not need the entire tax credit this year, you can carry it forward using the tax credit until it is used up or for 5 years which ever happens first.

You would still need to pay the 10% penalty for a premature distribution from your 401k or Traditional IRA. This is because of the way the tax form is structured.
We calculate our tax on form 1040 line 43, then on lines 46 thru 55 we calculate our tax credits to subtract from our tax (you may have dependent care credit, child tax credit, and then adoption credit in that order). Our credits can never take the tax to less than zero on line 56. Lines 57 through 61 add other taxes. Line 59 is where the 10% penalty is added to our tax bill.

You would be better served by moving the 401k to a Traditional IRA. This would give you more options for investing this Retirement Savings you have assembled.
Once you take the money out of the 401k, you can never put it back.