Questions To Consider Before You Buy
Your first step is to determine what your long-term goals are and how homeownership fits in with those goals. Perhaps youre simply looking to transform all those wasted rent payments into mortgage payments that give you something tangible: equity. Or maybe you see homeownership as a sign of independence and enjoy the idea of being your own landlord. Also, buying a home can be a good investment. Narrowing down your big-picture homeownership goals will point you in the right direction. Here are six questions to consider:
Roth Ira Withdrawal Rules
Most early withdrawals from a tax-advantaged retirement account before age 59 ½ cost you taxes and a 10% penalty, says Jeffrey Levine, certified public accountant and the director of advanced planning with Buckingham Strategic Wealth.
But with a Roth IRA, you may be able to avoid both taxes and penalties if youve had the account open for at least five years and use it to fund a first-time home purchase.
As long as your Roth IRA has been established for at least five years, you can use that money penalty-free for a home down payment as long as it qualifies as a first-time home purchase, Levine says. The nice thing about Roth IRA withdrawal is that the contributions you originally make can be withdrawn for anything, at any time without penalty. Its when you get into the earnings that you run into trouble.
Roth IRA withdrawal rules allow you to take out up to $10,000 earnings tax and penalty free as long as you use them for a first-time home purchase and you first contributed to a Roth account at least five years ago.
If you withdraw more than $10,000 in earnings, you could run into issues, Levine says. He recommends consulting with a knowledgeable tax professional before moving forward, just to be clear on penalties and other consequences.
Youll also want to make sure you use your withdrawn funds quickly. Money must be used within 120 days for the purchase and it must go directly toward the cost of the home, or you may end up owing taxes and penalties, says Roberge.
What Are The Rules & Penalties For Using 401 Funds To Buy A House
Heres a side-by-side look at some key differences between taking out a 401 loan and withdrawing funds from a 401.
|401 loans||401 withdrawals|
Must be repaid with interest in a certain period of time usually 5 years.
Qualified loans are penalty free and tax free, unless the borrower defaults or leaves their job before closing the loan.
The maximum loan amount is 50% of the vested account balance, or $50,000, whichever is less.
Interest accrued on the loan goes back into the 401, so the borrower is basically paying interest back to themselves. The interest is also tax-deferred until retirement.
If the borrower doesnt repay the loan on time, the loan is treated as a regular distribution and subject to taxes an early withdrawal penalty of 10%.
Do not have to be repaid.
Usually allowed only in the case of financial hardship, which can include medical expenses, funeral expenses, and primary home-buying expenses, if the individual meets strict IRS criteria for hardship.
Subject to income tax and a 10% early withdrawal penalty for people under age 59½.
One can only withdraw enough to cover the immediate expense , with a limit of 50% of the vested balance or $50,000whichever is less
You can only withdraw enough to cover the immediate expense , with a limit of 50% of the vested balance or $50,000 whichever is less.
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Do You Get Taxed On 401k After 65
Your tax depends on how much you withdraw and how much other income you have. The amount of a 401k or IRA distribution tax will depend on your marginal tax rate for the tax year, as set forth below the tax rate on a 401k at age 65 or any other age above 59 1/2 is the same as your regular income tax rate.
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How To Make A 401 Hardship Withdrawal
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If you need a significant sum of money and don’t expect to have the means to repay it, one option that may be available is a hardship withdrawal from the 401 at your current employer. Without the hardship provision, withdrawals are difficult at best if you’re younger than 59½. A hardship withdrawal, though, allows funds to be withdrawn from your account to meet an immediate and heavy financial need, such as covering medical or burial expenses or avoiding foreclosure on a home.
But before you prepare to tap your retirement savings in this way, check that you’re allowed to do so. Employers don’t have to offer hardship withdrawals, or the two other ways to get money from your 401loans and non-hardship in-service withdrawals.
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You Could Derail Your Savings Progress
It might be your goal to buy that house right now, but tapping into your retirement fund to make it happen might take you away from your future financial goals, experts say.
By tapping even a small portion of your retirement nest egg early, you run the risk of derailing the progress you have made in saving for retirement in addition to the penalties and taxes incurred, says Kenny Senour, a financial planner. Its true that you can begin to replenish the money you take out through your future paycheck deferrals, but it can take a long time to rebuild depending on how much is taken out.
Financial advisor Jenna Lofton says you may also lose out on compound interest if you pull out a large chunk of your savings and take years to pay it back.
If there was ever an investment where compound interest works in your favor, this is certainly one, says Lofton. These accounts are designed to have you living as comfortably post-retirement as you can envision yourself doing during pre-retirement.
A Deeper Dive On The 401 Loan Option
A loan is more strategic than a withdrawal, which torpedoes your savings altogether. With a full cash-out, instantly you lose a big chunk, paying a 10% penalty to the IRS if you leave the plan under age 55 plus another 20% for federal taxes. For instance, with a $50,000 withdrawal, you may keep just $32,500 and pay $17,500 in state and federal taxes. And the leftover sum you receive, if you happen to be in a higher tax bracket, may nudge you into paying even more taxes for that additional annual income.
Another adjustment in 2020 for workers affected by COVID-19: If your plan allows or through your IRA, you can withdraw up to $100,000 without the 10% penalty even if youre younger than 59½. The standard 20% federal tax withholding does not apply, but 10% withholding will unless you decide otherwise. You also can spread your income tax payments on the withdrawal over three years.
We understand emergencies can leave people with limited choices. Just remember that even the less extreme option of a 401 loan may paint your future self into a corner. The most severe impact of a 401 loan or withdrawal isnt the immediate penalties but how it interrupts the power of compound interest to grow your retirement savings.
At the very least, dont start stacking loans . Some employer retirement plans allow as many as three.
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Qualifying For The 401k Hardship Withdrawal
Under normal circumstances, you cannot withdraw from your 401K until you are 59 ½. The only exception to the rule is if you take out a 401K loan. The 401K withdrawal, however, is not a loan. It is a permanent withdrawal of the money. In order to qualify, you must prove some type of hardship. A few examples include losing your job and still trying to recover or being unable to work due to a medical condition.
Each plan administrator has different requirements regarding the proof of a hardship. Talk to your employers HR department about what you need to provide. Basically, you will have to prove you do not have any other money and explain why. Your reasons must be able to be proven so the HR department can approve your request to withdraw the money early.
Traditional 401 Penalty Exceptions
A traditional 401 provides a tax deduction on contributions, and taxes withdrawals as ordinary income. Normally, early withdrawals are subject to a 10 percent penalty tax, but exceptions are available. Early withdrawals escape the penalty if they result from job separation after age 55, rollover into another retirement account, death, total disability, financial hardship, medical bills exceeding 7.5 percent of your adjusted gross income or substantially equal regular payments based on your life expectancy. Even if you meet one of these exceptions, it’s important to keep in mind that if you withdraw money from your traditional 401 to purchase a home or for any other reason, that money will still be taxed as income.
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Can I Claim Uif When I Retire
If you retire, you may receive benefits from a retirement fund or annuity. However, you will not receive benefits from the UIF. If you never claimed from the fund, its either because you did not qualify for benefits or you chose not to apply for benefits when you may have been eligible for the benefits.
Should You Use A 401 When Buying A House
Buying a house can be a great investment, but its also expensive. Theres the cost of the property and ongoing monthly payments.
In addition, there are out-of-pocket expenses associated with getting the actual mortgage.
Nowadays, many home loan programs require down payments that range from 3 percent to 5 percent of the sale price.
Buyers are also responsible for their own closing costs. This is an extra 2 percent to 5 percent out-of-pocket.
If you dont have enough in personal savings, the good news is that you might be able to get your hands on funds.
If you have a 401, you can tap this account and use these funds for your down payment and closing costs.
But, should you?
Heres how using a 401 when buying a house works, and what you can expect from the process.
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Low And No Down Payment Mortgages
Instead of getting a loan for your down payment, you can look into some of the government-backed loans that offer low and no down payment mortgages.
FHA Loans FHA home loans require a low 3.5% down payment, making them a prevalent option. With a down payment this low, you may not need to use your retirement account to afford the down payment.
VA Loans If youre a Veteran, you could qualify for a VA home loan with no down payment. This is one of the greatest benefits offered to Vets in our Country. Not only do VA loans provide 100% financing, but no mortgage insurance is required.
USDA Loans The U.S. Department of Agriculture guarantees USDA loans for low-to-median income families in the countrys rural areas. TDA finances 100% of the purchase price for eligible borrowers.
Conventional 97 Loan This type of conventional loan was created by Fannie Mae to compete with the low down payment government-backed loans. As the name suggests, a conventional 97 loan offers a 3% down payment, allowing you to finance 97% of the purchase price.
Home Possible / HomeReady Loans Fannie Mae and Freddie Mac created the Home Possible and HomeReady loan programs for first-time homebuyers who meet the income limits, have a 620 credit score and a 3% down payment. Your income must be below 100% of the area median income to be eligible.
What Hardship Withdrawals Will Cost You
Hardship withdrawals hurt you in the long run when it comes to saving for retirement. You’re removing money you’ve set aside for your post-pay-check years and losing the opportunity to use it then, and to have it continue to appreciate in the meantime. You’ll also be liable for paying income tax on the amount of the withdrawaland at your current rate, which may well be higher than you’d have paid if the funds were withdrawn in retirement.
If you are younger than 59½, it’s also very likely you’ll be charged at 10% penalty on the amount you withdraw.
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How Much Of 401k Can Be Used For Home Purchases
How much you can take from your 401k depends on the terms and conditions your holder has in place. In some cases, you might have the option to withdraw the entire account, and in others, there might be a cap in place to prevent you from doing so. Either way, its not recommended that you take the entire account. Instead, you should only take a portion to cover your down payment, as its better for you, in the long run, to leave as much of your account intact as possible.
Repayment If You Leave Your Job
If you think youll want to leave your job in the next few years, review what your plan says about 401 loan repayment if you leave. Some 401 plans require you to repay the entire loan balance if you leave your job.
If you dont repay the loan in full, the unpaid amount will be treated as a withdrawal from your retirement account. Youll be required to pay income tax on the distribution and if youre under 59 ½ or dont meet another exemption, you may be charged a 10% penalty.
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Withdrawing From A 401
The first and least advantageous way is to simply withdraw the money outright. This comes under the rules for hardship withdrawals, which were recently made a little easier, allowing account holders to withdraw not just their own contributions, but those from their employers. Home-buying expenses for a “principal residence” is one of the permitted reasons for taking a hardship withdrawal from a 401.
You owe income tax on the withdrawal.
The withdrawal could move you to a higher tax bracket.
If you are younger than 59½, you also owe a 10% penalty on the money you withdraw.
You can never repay your account and lose years of tax-free earnings on the money you withdraw.
If you withdraw money, however, you owe the full income tax on these funds, as if it were any other type of regular income that year. This can be particularly unappealing if you are close to a higher tax bracket, as the withdrawal is simply added on top of the regular income. There is a 10% penalty tax, also known as an early withdrawal penalty, on top of that if you are under 59½ years of age.
401 plans do not have a first-time homebuyer exception for early withdrawals, but IRAs do.
Missing 401 Investment Returns
When you have an outstanding 401 loan, that money is not being invested or generating additional returns for your nest egg. Cannova notes that it’s not as big a deal if you happen to be borrowing when the market is doing poorly. However, if the market is returning 8 to 10 percent and you’re only paying 4 or 5 percent on your loan, that’s a substantial difference that could limit your retirement savings. For example, if you had $25,000 earning five percent over just one year, you’d make $1,250 less than if your rate was 10 percent.
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Question : What Is Your Current Vested Balance
Your vested balance does not equal your total balance. Instead, this term refers to how much of your employer-sponsored plan would go with you if you were to leave your job or withdraw your 401 right now. While every dollar you contribute to your 401 is your money, the company-matching funds in your account are not immediately all yours. Every year, a certain amount of the matching funds is vested. Once youre fully vested, you can then claim the entirety of the employer match.
Note:Every employer is different with regard to the vesting period, and you will want to speak with your plan administrator if you have been with the company for fewer than six years . The IRS has a helpful entry on this topic.
Below is a snapshot of what Mark and Katies retirement plans look like:
Katie has been with her company just over two years and is only 20% vested. She also had a 401 at a previous employer rolled over into an IRA.
How To Use Your 401 For A Down Payment
While its possible to fund a down payment from a 401, its generally not recommended. Still, if you want to proceed, there are two main ways:
These are the key differences between 401 loans and withdrawals:
|Amount limited to the lesser of 50% of your vested account balance up to $50,000||Cant exceed the amount needed to purchase your home|
|Might become due in full if you lose or leave your job||Not affected by losing or leaving your job|
|Not taxable unless you fail to repay it||Income tax is due on the amount withdrawn|
|No tax penalty unless it isnt repaid||Might incur a 10% early withdrawal tax penalty|
|Might not be able to make new contributions during loan repayment||New contributions can be made after|
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