With the difficulty in the housing market, and an increasing number of foreclosures, many people are looking for help with their mortgage payments. For many people their 401k account is their largest untapped resource of funds. Unfortunately, using your 401k for mortgage payments or other reasons can be tricky, and expensive.
401k Withdrawal for Mortgages
Most 401k plans do not allow current employees to withdraw funds from their current 401k. There are two major exceptions.
Remember that all 401k plans are governed by their own specific rules as specified in their plan document. The features described below are allowed, but not required, by IRS rules. As such, they may not apply to your employer’s 401k plan.
A 401k hardship withdrawal allows a current employee to withdraw money from their 401k account for expenses that are “immediate and heavy.” Immediate and heavy expenses can include payments necessary to avoid foreclosure or eviction, or even expenses associated with purchasing a home. There is no need for an expense to be “unforeseen” when it comes to hardship withdrawals from a 401k plan.
An in-service withdrawal from a 401k is a provision that allows a current employee to withdraw a portion of their current 401k balance. Typically, an in-service withdrawal is used to rollover funds from a current 401k to an IRA or other qualified retirement plan. However, an in-service withdrawal can be used to finance a mortgage if necessary.
Unfortunately, in neither case are the taxes or early withdrawal penalty on 401k plans waived. That means that you will still owe taxes on all withdrawn amounts. For those under 59 1/2 years old, there will also be a 10 percent tax penalty on withdrawals.
401k Loans
Some 401k plans offer loans from their 401k. Essentially, an employee takes a loan from his 401k and then pays it back to the plan over time. 401k loans typically have to be repaid within 5 years, however, 401k loans used to purchase a primary residence are exempt from this requirement.
Be careful with 401k loans however, There are many downsides to a 401k loan.
401k First Time Home Buyer Exception
One of the trickiest thing about financial planning is that there are often rules that apply to only certain types of investments and accounts. This is doubly true in retirement planning where the rules for 401k accounts, IRA accounts, 457 plans and 403b plans all are very similar, but not the same.
Many people have heard of an exception that allows an early distribution from a retirement account to buy their first home. Unfortunately, this first-time home buyer exception for 401k withdrawals doesn’t exist.
However, an IRA allows an early withdrawal for purposes of a first-time home purchase. This rule offers an exemption from the usual early withdrawal penalty for people under 59 1/2 who are taking money out of a retirement account.
The first-time home buyer exemption for early withdrawals applies to IRA accounts, but NOT to 401k accounts.
Withdrawing Money from 401k for Mortgage
Many people wonder when they can take money out of a 401k to help with a mortgage or to buy a home.
The answer is that you can take money out of a 401k at any time so long as you have separated from service (no longer work at that company).
That does not mean that you can take money out of a 401k tax-free.
All withdrawals from a 401k (except for Roth 401k contributions or other non-deducted deposits) are considered income and are subject to ordinary income taxes. In addition, anyone under 59 1/2 years old taking money out of a 401k will be hit with a 10 percent tax penalty.
Be sure to run the numbers before taking money out of your 401k plan for your mortgage. The taxes may be so high that is isn’t worth it.
You may also want to consider using a Roth IRA as an emergency fund.