Using 401(k) to pay for house

[JRB]

Does anyone know if you can use a 401(k) distribution to pay off a home loan without incurring a penalty?

[Martha]

How old are you? Are you still at the job with the 401(k)?

[Austin_Explorer]

You could use a 401k loan if you still work at the company. We did that to pay down the principle on our house in order to refinance at a more advantageous rate.

[JRB]

Martha,

I am 55 and would like to retire by 60 but I would like to pay off the home loan before I retire.

I am still working at the job with the 401(k).

[Martha]

Companies can make their own restrictions on 401(k) loans so it might not allow you to borrow the money from the 401(k). Also, it doesn't look like you want to have to pay it back. You do have to pay back the loan or risk a deemed distribution and penalties might apply. I don't know if you could dance around the penalties by not defaulting until you are 59 and a 1/2.

Because you are over 55, when you leave the company you can take a lump sum distribution, and you will pay no penalty, only the income tax. The tax code says that no penalty applies to distributions "made to an employee after separation from service after attainment of age 55." But you have to leave work first.

If you wait until 59 and a half, you can freely take the money out with no penalty, only the income tax will have to be paid.

[JRB]

Martha,

Thanks. It looks like I'm on the hook until 59 1/2.

[Martha]

BTW, here is the IRS publication on 401(k) distributions: http://www.irs.gov/publications/p575/index.html

[JRB]

Thanks. I just printed it out. It will take some serious reading time to work through it. :P

[charlie]

Don't forget that if you take a loan against a 401k you have to
pay back the loan with after-tax dollars ..... then you get taxed
again later at earned income rates when you withdraw at
retirement. The loan dollars get taxed twice! ..... lovely

Cheers,

Charlie

[Theo]

Of course, when you take that loan, it's using pretax dollars, so you're spending earned income without paying taxes on the income when you take the loan and spend it on whatever...

I imagine it evens out, otherwise you'd get double deferrals, first when you elected to defer the income, then again when you paid the loan back.

[ShokWaveRider]

What about taking 72(T) SEPP Payments?

SWR

[Martha]

Quote:

Originally Posted by ShokWaveRider What about taking 72(T) SEPP Payments? SWR

I think 72(t) (substantially equal periodic payments) are available for 401(k)s only if you no longer work for the employer.

[Austin_Explorer]

Quote:

Originally Posted by Martha I think 72(t) (substantially equal periodic payments) are available for 401(k)s only if you no longer work for the employer.*

Actually I think 72(t)'s only work on IRA's. One can draw down on a 401(k) after 55, if you no longer work there. Don't think there's an option to do SEPPs from a 401(k) prior to 55 and termination of employment.

[Martha]

From IRS tax topic which describes the circumstances where there is no 10% penalty on early withdrawl:

The following five exceptions apply to distributions from any qualified retirement plan:

1. Distributions made to your beneficiary or estate on or after your death.
2. Distributions made because you are totally and permanently disabled.
3. Distributions made as part of a series of substantially equal periodic payments over the life expectancy of the owner or life expectancies of the owner and the beneficiary. If these distributions are from a qualified plan other than an IRA, you must separate from service with this employer before the payments begin for this exception to apply.
4. Distributions that are equal to or less than your deductible medical expenses, that is, the amount of your medical expenses that is more than 7.5% of your adjusted gross income. You do not have to itemize to meet this exception. For more information on medical expenses, refer to Topic 502.
5. Distributions made due to an IRS levy of the plan.

The following additional exceptions apply only to distributions from a qualified retirement plan other than an IRA:

1. Distributions made to you after you separated from service with your employer, if the separation occurred in or after the year you reached age 55,
2. Distributions made to an alternate payee under a qualified domestic relations order, and
3. Distributions of dividends from employee stock ownership plans.

The following exceptions apply only to distributions from IRAs:

1. Distributions equal to or less than your qualified higher education expenses,
2. Distributions made to pay for a first–time home purchase, and
3. Distributions made to pay health insurance premiums if you are unemployed.

[JRB]

Martha,

Does that mean if I retire from my job (I am already 55) I can take a one time distribution to pay off the home loan before I transfer the 401(k) to an IRA?

[Martha]

Yes, of course you have to pay income taxes, but there is no penalty.

[JRB]

Many thanks.