Can I Draw From A 401k For A Home Purchase Without Being Penalized With Taxes
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Buying a new home often requires a hefty down payment and finding the cash can be tricky. To make the numbers work, some homebuyers turn to the money in their 401. You do have the option of borrowing against your 401, but you’ll have to pay that money back. Your plan may allow you to make a hardship withdrawal instead, but you’ll get charged a penalty for doing so. If your 401 is your only source of cash and you’re buying your first home, your best option is to roll the 401 money into an individual retirement arrangement . You may still have to pay taxes, but you can use those funds to buy a home while avoiding both penalties and the need to repay the money.
Tip
Under the rules of many 401 plans, if you take out a 401 loan your contributions to the fund are stopped until the monies are paid back to the 401. The loan repayments are not tax deductible while the contributions were, so weigh the advantages and disadvantages, tax wise.
Using A 401k Hardship Withdrawal For Home Purchase
April 26, 2017 By JMcHood
A large down payment is what makes a home purchase possible for many people. Lenders like to see at least 20% down on a home. This helps make the loan less risky for the lender. The more money you have invested in the property, the more likely you are to make your payments. What happens if you cannot come up with a down payment, though? Maybe you lost your job and are trying to make ends meet or you had to use your savings on a medical emergency. There is one option it is called the 401K hardship withdrawal.
Using 401k Funds For Down Payments
First-time home buyers who are unable to come up with a down payment can withdraw from their 401ks in order to gain access to funding quickly. When pulling from a 401k, borrowers only have access to the vested amount in their account, rather than the ending balance. This is simply because company matching funds may not be not immediately made available to pull from.
Withdrawing from your 401k before you hit retirement age always incurs penalties and fees. There are also different methods for withdrawing from your funding.
The hardship withdrawal option allows first-time home buyers to withdraw $10,000 from their 401k without incurring the 10% IRS penalty. However, buyers will have to pay income tax on this withdrawal come tax season.
The 401k loan option lets buyers borrower whichever of the below two options is less:
- 50% of the vested 401k balance
- Up to $50,000
Repayment terms are generally within 5 years and often come directly out of an employeeâs check.
A combination of the above two options can also be utilized if you have more than one 401k.
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Set Up Your Plans To Be Self
Several tax-advantaged vehicles include a defined benefits plan, a 401 profit-sharing plan, solo 401, employer-sponsored 401, traditional IRA, and Roth IRA. With any variation, all the documents need to allow you to invest your funds as self-directed for you to invest in real estate. Once self-directed, you can hold alternative investments in your retirement account.
A defined benefit plan is an employee-sponsored retirement plan that is regulated by the Employee Retirement Income Security Act of 1974 and the IRS. They offer higher allowances to defer income based on how much your company earns and are more intricate to set up. Annual government forms are required for all plans if you have retirement assets over $250,000.
If you own a business with no full-time employees other than your spouse, you can set up an individual 401. If you write these plans with a maximum amount of flexibility, you will have many advantages, including check-writing capability. Check writing gives the owner of the plan owner complete signing authority over an account that offers access to their retirement funds. With check writing, the individual monitors their own activity.
Find out how your plan is set up, and remember there are still advantages to advancing your retirement. You can utilize a company match, or if you qualify for a Roth 401 and the company offers both, you can start growing your investments tax-free.
Borrowing From Your 401 To Buy A House
Doretha Clemons, Ph.D., MBA, PMP, has been a corporate IT executive and professor for 34 years. She is an adjunct professor at Connecticut State Colleges & Universities, Maryville University, and Indiana Wesleyan University. She is a Real Estate Investor and principal at Bruised Reed Housing Real Estate Trust, and a State of Connecticut Home Improvement License holder.
Buying a home is an exciting milestone, but it often requires a significant financial investment. While it’s important to calculate how much home you can afford and how your monthly mortgage payments will affect your budget, there are other costs to consider.
Two of the most important are your down payment and closing costs. According to the National Association of Realtors, the median home down payment was 12% of the purchase price in 2019. That would come to $24,000 for a $200,000 home. Closing costs, which include administrative fees and other costs to finalize your mortgage loan, add another 2% to 7% of the home’s purchase price.
While the seller may pay some of the closing fees, you’re still responsible for assuming some of the costs. You can borrow from a 401 to buy a house if you don’t have liquid cash savings for the down payment or closing costs. Here’s what to consider before you make that move.
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Alternatives To Withdrawing From Your Retirement Fund
Keep in mind there are alternative financing methods that can help you leave your retirement savings intact. Think about utilizing one of these four methods so you don’t have to disrupt your retirement fund.
1. Withdraw from your IRA
Even though your IRA is still retirement savings, there may be advantages to choosing this investment vehicle over your 401k. In particular, if your Roth IRA plan allows for hardship withdrawals, you’re allowed to withdraw any amount. However, even if hardship withdrawals are not allowed under your plan, as long as you’re a first-time homebuyer, you can withdraw up to $10,000 tax-free to go toward your down payment.
On the other hand, if you have a traditional IRA, you also have the option of taking out up to $10,000 to go toward your down payment. You won’t be required to pay any early withdrawal penalties on this money, but it will be taxed as income. If you take out a distribution larger than $10,000, you will pay a penalty and regular income tax on that amount.
2. Take out a personal loan
Typically, acceptance for personal loans is based on your income and . While every lender is different, in some circumstances, it’s possible to take out up to $100,000 to put toward a down payment.
3. Ask for a gift
4. Use a down payment assistance program
How To Use A 401 Loan To Buy A House
A 401 loan is the preferredmethod if you need to cash out some of your 401 retirementfunds tobuy a house. Thats because theres a much lower cost associated with a 401loan comparedto a 401 withdrawal.
You should also know:
- A 401 loan is usually not counted in your debt-to-income ratio, so it wont hurt your chances of mortgage qualifying
- 401 loans are not reported to credit bureaus, so applying for one wont harm your credit score
Can I use my 401k to buy a house without penalty?
Unlike a 401 withdrawal, a401 loan is not subject to a 10% early withdrawal penalty from the IRS. Andthe money you receive will not be taxed as income.
The rules for using a 401 loanto buy a house are as follows:
- Your employer must allow 401loans as part of its retirement plan
- The maximum loan amount is 50% ofyour 401svested balance or $50,000, whichever is less
- The loan must be paid back withinterest , on a schedule agreed to by youand your 401 provider
- Typically,you cannot make 401 contributions while you have an outstanding 401 loan
401 loans typically need to bepaid back over five years.
However, when the money is used topurchase a home, youre usually allowed to pay it back over a longer period oftime. Rules vary by 401 company, so check with yours to learn more.
Drawbacks to 401 loans for home buying
While youre paying back the 401 loan, you usually cant make new contributions to your retirement account. And that means your employer wont be matching contributions, either.
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Get A Bank Loan Inside Your Retirement Plan
Getting a bank loan inside a retirement plan is not very common. A Google search comes up with almost no information on the subject, and Im not surprised that a CFP on my payroll told me it wasnt possible. But Ive since learned that depending on the plan documents, it is.
Here is how it works. The lenders qualify your eligibility using a 60-65% LTV and look at how much is in the retirement account to get the loan. Only certain banks offer these loans NASB is one of the most popular ones.
Retirement plans have many prohibited transactions that need to be considered in the loan, including not allowing disqualified persons to benefit, meaning yourself or an immediate family member. A disqualified plan pays hefty fines and loses the benefits.
The loan rates are higher , and flippers are vulnerable to UBIT tax but other than that, it is a viable lending option.
You can even utilize a 1031 exchange. All retirement funds, unless taxes are paid, stay inside retirement plans and the funds remain tax-deferred. A disadvantage is there is no depreciation capture opportunity, but a bonus is that the loan application is also only two short pages.
Buying A Home Is A Big Financial Investment And Even If You Dont Have The Cash To Purchase A Home Outright Youll Probably Still Need Money On Hand For A Down Payment
If you havent saved for a down payment, though, you might be considering other ways to get access to the money you need now, including your 401. Thats because some 401 plans let you borrow money from your retirement savings and pay it back over time.
But even if you arent planning to retire any time soon, taking a loan from your 401 can come with big drawbacks, like missing out on potential investment growth. So before you dip into your nest egg, consider if its really the best option for you.
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Should I Make A 401 Withdrawal Instead
Withdrawing money from your 401 before retirement, as opposed to borrowing from it, is usually a bad financial move. Not only will you be taking the money that youve invested for your golden years leaving you with less for retirement you may be hit with an early-withdrawal penalty.
Unless youre 59½ or qualify for another exception, youll have to pay tax on the amount you withdraw plus a 10% penalty. Though that penalty may be waived on up to $10,000 withdrawn from a traditional, SIMPLE or Roth IRA if you use the money to buy, build or rebuild your first home.
If youre experiencing financial hardship, your plan may offer the option of a hardship withdrawal. Youll still need to pay tax on the withdrawal amount, and you may also need to pay the 10% penalty. But the amount you take for a hardship withdrawal cant be paid back to your retirement plan like a 401 loan can.
Consider An Ira Rollover
The rules for IRAs are different than those for a 401 and are more favorable to first time homebuyers. As a first time buyer, you can withdraw up to $10,000 from an IRA without paying any penalties on the money. If your IRA is a Roth IRA, you can make the withdrawal tax-free because you paid taxes on the money before you saved it. If you have a traditional IRA, you will have to pay taxes on the money because you didn’t do so when you first put it in your IRA account. This is true whether you make a withdrawal to buy a home or upon reaching the magical age of 59 1/2.
If you have money in a 401 but like the homebuying benefits of an IRA, all is not lost. You may take money out of your 401 and roll it into a traditional IRA. To avoid any fees or penalties, ask your 401 plan manager to transfer the funds directly or make the check out to your IRA rather than to you personally. Once the money becomes part of your IRA, you can withdraw it to purchase a house under IRA rules rather than under the less favorable 401 rules.
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Withdrawing Money From A Roth Ira
Using a Roth IRA to buy a first home is one alternative to borrowing from a 401 that can be beneficial for some home buyers. Unlike 401s, Roth IRA contributions are made with after-tax dollars. This means at the time of the withdrawal, the funds can be taken out tax-free .
Other reasons why it might make sense to use a Roth IRA to purchase a first home:
Roth IRA contributions can be withdrawn without penalty at any time. After the account has been open for five years, Roth IRA account holders who are buying their first home are allowed to withdraw up to $10,000 in investment earnings with no taxes or penalties. Roth IRA funds can be used to help with the purchase of a first home not only for the account holders themselves, but for their children, parents, or grandchildren.
One last requirement to note is that time is of the essence when using a Roth IRA to purchase a first home: the funds have to be used within 120 days of the withdrawal.
Getting A 401 Loan For A Home
If you’d like to use your 401 to cover your down payment or closing costs, there are two ways to do it: a 401 loan or a withdrawal. It’s important to understand the distinction between the two and the financial implications of each option.
When you take a loan from your 401, it must be repaid with interest. Granted, you’re repaying the loan back to yourself and the interest rate may be low, but it’s not free money. Something else to note about 401 loans is that not all plans permit them. If your plan does, be aware of how much you can borrow. The IRS limits 401 loans to either the greater of $10,000 or 50% of your vested account balance, or $50,000, whichever is less. For example, if your account balance is $50,000, the maximum amount you’d be able to borrow is $25,000, assuming you’re fully vested.
In terms of repayment, a 401 loan must be repaid within five years. Your payments must be made at least quarterly and include both principal and interest. One important caveat to note: loan payments are not treated as contributions to your plan. In fact, your employer may opt to temporarily suspend any new contributions to the plan until the loan has been repaid. That’s significant because 401 contributions lower your taxable income. If you’re not making any new contributions during your loan repayment period, that could push your tax liability higher in the interim.
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Can You Use 401k To Buy A Second Home
Good news you can use your 401k to buy a second home. You can, in fact, withdraw from 401k for home and use the amount to purchase a second home or vacation retreat. While you could be hit with a 10% tax penalty, several exceptions are possible for you to sidestep this massive downside. You should note that withdrawals arent state-specific when it comes to penalties, your state income tax may be affected.
How Much Home Can You Actually Afford
Sometimes a bank will give you a loan for more house than you really want to pay for. Just because a bank says it will lend you $300,000 doesnt mean that you should actually borrow that much. Many first-time homebuyers make this mistake and end up house-poor with little left after they make their monthly mortgage payment to cover other costs, such as clothing, utilities, vacations, entertainment, or even food.
In deciding how big a loan to actually take, youll want to look at the houses total cost, not just the monthly payment. Consider how high the property taxes are in your chosen neighborhood, how much homeowners insurance will cost, how much you anticipate spending to maintain or improve the house, and how much your closing costs will be.
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How Much Of My 401k Can I Borrow To Buy A House
In general, you can only borrow from 401k to buy home up to 50%, or $50,000, whichever is less. Some plans may even offer an exception if your balance is less than $10,000, allowing you to withdraw the entire amount. On the other hand, withdrawing from 401k for house is unlimited, assuming your plan will enable you to do so. Your first step should be to contact your employer before making any offers on a home, assuming you can take from your 401K.
You want to keep more of your money than spend it at least most people do! Thats why Richr gives 2% back to home buyers, so they dont have to risk their 401K or quickly replenish it with the funds received. Building wealth for tomorrow starts with the choices you make today.