My wife recently started contributing to her employers 401(k) plan. Now we are expecting our first child and she will be quitting her job. Her employer will disburse the 401(k) savings to her less 20% federal taxes. If we rollover the check into an IRA, we must pay the 20% tax difference to avoid the 10% penalty tax. If we cash the check, we are subject to an additional 10% penalty tax. We would like to apply the proceeds to her medical bills. By paying medical bills are we exempt from the 10% penalty tax? Also, we are in the lowest tax bracket. Is it possible to get a tax refund of the 20% federal tax witholdings?