Can I use my 401K to Buy a Home?

It is possible to withdraw money from your 401k to buy a home. However, the process is not simple, and it will cost you a lot of dollars in fees. If you cannot locate financing through another option, then you may consider this as a last resort maneuver to purchase your home.

401K Hardship Withdraw

You will need to pursue a hardship withdraw in order to get funds to finance the purchase of your home for a hardship withdrawal. Not all companies offer this benefit; it is not mandated by the federal or state governments. You must first see if your employer is willing. Then, you will have to determine how much you have fully-vested in your 401K. Typically, you can borrow up to 50% of the amount you have fully-vested; this means all the deposits that have been completed by the time you withdraw.

If you determine you are able to withdraw from your company, then you will need to show you cannot get the funds in any other way. Most companies offer 401K loans as options before a 401K withdraw. If your company offers this, they will require you use this option first. They will also require proof that you cannot get a mortgage loan from another resource.

Taxes & Fees

Just because your company approves the withdraw does not mean it is without penalty. The funds you placed in your 401K were contributed tax free. When you take those funds out, the withdraw counts as income. This means you will have to pay taxes as part of your yearly income. The average tax rate on a 401K withdraw is 20%.

Aside from taxes, you will be penalized for withdrawing. The penalty rate is 10%. Ultimately, you will have to withdraw 30% more money than you actually need for your home purchase simply to make the withdraw serve the purpose you intend. This is a very expensive option. Again, it is truly a last resort option.

Alternatives to Withdrawals

401K loans are not the only other options to a 401K withdrawal. While this is a viable alternative, 401K loans typically have very high interest rates and will not be the best option on the table. Seeking a mortgage loan from a private source is a better choice.

Most people considering hardship withdraws do not have an issue getting a loan, they may just not have the down payment needed. If you have fair credit, you may be able to meet FHA requirements for a low down payment loan. The Federal Housing Agency will guaranty loans for individuals who meet minimum requirements. This means you can place less money down and also achieve a lower interest rate on your mortgage. Lenders will be more willing to work with you if you have the backing of the federal government. You can approach an FHA qualified lender to immediately learn if you are a candidate for this type of loan.

You may also consider taking out a personal loan to cover your down payment. This can be expensive, but it will ultimately be cheaper than a withdrawal in most cases.

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How Much Should I Contribute to a 401k?

Contributing to your 401K allows you to place before tax funds into a retirement account. This means you will have the ability to increase your income in a given year by a large percentage simply by saving instead of spending the money. The ability to increase your income is raised even more by employer contributions, if your company offers one. Ultimately, it is wise to place the maximum amount you are permitted into a retirement account each year.

Leaving Money on the Table

When you do not capitalize on the maximum contributions your employer will match, you are basically leaving money on the table each year. Your employer determines your salary on a total compensation basis. This includes all office services and perks, not just financial benefits. However, the greatest factors considered are your benefits and 401K options. If you are not taking advantage on the funds your employer offers to your 401K, then you are simply turning down a portion of your income each year. Your employer will not offer to simply give you this money in cash. The only way to get that extra 3-10% each year is to save the money in a 401K.

Not Saving for Retirement

Another reason it is prudent to save the maximum amount is the long term benefit of saving for retirement. Especially early in your career, it is easy to think that you will save for retirement in the future. However, retiring is much more expensive than it used to be. The cost of health care has gone up. People are also living longer, meaning they have more post-working years to cover for. The salary you make today has to support you in your old age. You never know what will happen in the future; this may be the highest salary you ever make. If it is, are you prepared to retire?

Paying Unnecessary Taxes

You are taxed on the money you do not contribute to a 401K, but you are not taxed on the money you do. When you neglect to contribute to a retirement account, you are paying unnecessary taxes each year. Taxes can amount to about 25% of a middle-class person’s income. If you can pay 5% less simply by saving that money for later, why wouldn’t you? When you think of things on these terms instead of being concerned with how much you have to spend on luxury items each week, it simply makes sense to contribute the maximum to your 401K.

Tip: Budget Your Savings

Of course, not everyone will be able to live off a salary that is reduced by 6 or 10% given to a savings account. That’s okay, just contribute what you can afford. Determine what you can afford by cutting your income in half once. Then, from the remaining sum, deduct your fixed expenses such as rent, insurance, auto payments and student debt. Do not consider food or utilities in this factor. How much is left? This is how much you can afford to save each month and still make ends meet.

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Traditional versus Roth IRA

Today, the Roth IRA has almost totally eclipsed the traditional IRA option. The Roth IRA is more flexible than the traditional option. Depending on your needs and how much you will contribute annually, though, you may elect the traditional option instead.

Traditional IRA

• Deposits are tax deductible depending on how much you make each year
• You can start withdrawing at 59 1/2 and MUST withdraw at 70 1/2
• Taxes are paid on the earnings from the account when they are withdrawn from the account
• You can purchase a number of investments, not just traditional investments
• There is no income limit, anyone can open a traditional IRA
• Funds withdrawn before 59 1/2 are generally penalized at 10%

Roth IRA

• Contributions are not tax deductible, and the taxes are applied before contribution
• There is no minimum age for distribution
• ALL Earnings and principal in the Roth IRA account are 100% tax free
• You can purchase a number of investments, not just traditional investments
• You are only eligible if you are a single-filer, making less than $95,000 OR if you are joint filing with a spouse and make less than $150,000 combined
• No early withdrawal fees!

Notable Differences

The main difference here is the Traditional IRA is the way contributions are taxed. For a Traditional IRA, you deduct your contribution from your reported income. You will not pay taxes again on that principal amount, but you will have to pay taxes on your gains and interest on those dollars.

With a Roth IRA, you pay your taxes up front. You place funds in after they have been taxed as part of your income, and you do not get to deduct those contributions yearly. However, once the funds are in the account, they grow totally tax free. When you make a withdrawal, you are not taxed on those fees or penalized for withdrawing early.

Which is Best?

There is no single option that is best across the board, but there are some reasons one may be preferable to you.

• First, if you make more than the limit accepted by the Roth IRA program, you will not have an option. You will have to choose a Traditional IRA if you make more than $95,000 and file a single or if you make more than $150,000 as a couple filing jointly.
• If you are in a low income tax bracket at this point, it may be most  beneficial to contribute to a Roth IRA options. This allows you to pay the taxes on your lower income, and then you do not get assessed any taxes no matter your income bracket in the future.
• The Roth IRA contribution limit is very low; you can only contribute $5,000 each year to this plan. If you can afford to put more than this toward retirement, it is a good idea to start doing so as early as possible. A Traditional IRA has much higher limits; a 401K option through your employer will also have a higher limit. You may be able to mix and match your options to contribute the maximum each year.

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Hardship Withdrawal from a Retirement Account

Your retirement account is reserved for use only after you meet the minimum retirement age. Because of this, some retirement account options will present penalties if you elect to withdraw. Different types of accounts will present different penalties in the case you require funds before you reach a minimum age.

IRA hardship withdrawal

There are two different types of IRA accounts: a traditional IRA and a Roth IRA. With a traditional IRA, there is a minimum withdrawal age, but there is a lifetime exemption on withdrawals up to $10,o00 toward the purchase of a home. A Roth IRA has not minimum age for withdrawal. Further, since taxes have already been paid on contributions to this structure, you will not face additional fees when you take the money out. You will lose the ability for the funds to continue growing in the account tax free, however.

401K hardship withdrawal

You should consider taking a loan against the funds in your 401K fund before withdrawing any. However, if you are not able to do this, your employer may offer a hardship option. The government does not require this option, so you will have to check your plan to see if you are eligible. Even if your employer and financial management company offer the option, you will have to meet basic criteria in order to qualify. You must:

• Have an immediate and severe need
• Be unable to get funds in another way
• Obtained all non-taxable loan options with your 401K provider
• Be taking out only enough funds to cover your immediate need

Even once you meet these qualifications, you cannot simply spend the funds on any item you wish. There are only certain items the funds can go toward, including and limited to:

• Purchase of a primary residence
• Higher education tuition for you, your spouse or your child
• Preventing eviction from your primary residence
• Severe financial hardship
• Medical expenses that are not tax-deductible and not covered

Even after meeting all of these criteria, you will still have to pay fees and taxes on the funds you take out of your 401K. There is a 10% penalties for withdrawing before you reach the age of 59 1/2. You will have to pay approximately 20% of your withdrawal to taxes.

Non-financial hardship withdrawal

There are certain circumstances that will allow you to forgo fees on your early withdrawal, even though you will still owe taxes. These circumstances include:

• Totally and permanent disablement
• Medical debts exceeding 7.5% of your gross income
• You are ordered by a court to provide funds to a divorced spouse, child or dependent
• You have been permanently laid off, terminated, quit or retired early in the same year you turn 55 or older

Since you are not the one controlling the spending in these cases, the government will allow you to withdraw funds without paying the necessary fees. If you are over the age of 55, certain other exceptions may be allowable under your plan. Ask your financial manager about setting up a regular withdraw schedule.

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401K Hardship Withdrawal Options

The government provides a tax deferred 401K option in order to encourage you to save for your retirement. The government ultimately benefits from this plan because it reduces the burden placed on senior services, such as Social Security and Medicare. However, you may need the funds before you actually retire. Withdrawing directly from your fund will create large penalties, but there are options to tap into the savings without the penalties.

Borrow against your 401K

Some financial management firms offer ways to borrow funds using your 401K as collateral. The government does not require all providers to have this option; you should check with your 401K manager to see if you are eligible. These loans are not subject to the taxes assessed on 401K withdrawals. They are also not subject to the penalties assessed for withdrawing from your retirement fund before the age of 59 1/2. The government does not set restrictions on how and when the funds can be used. Your employer or your financial management firm may, however. There may be minimum loan requirements. You may also need to have all beneficiaries of your plan, such as a spouse, sign off on the loan.

Loan limits

Most employees are permitted to borrow up to 50% of their vested 401K balance. This is set by each employer, however, so you may be subject to different limits. The limits usually cap at $50,000. These limits are partially cumulative. This means, if you have borrowed against your 401K in the previous year, you will have to factor the other loan into your limits. You will only be able to borrow up to 50% of the amount with a limit of $50,000 minus your existing loan. All loans have a maximum 5 year maturity period. Home loans may have a longer period, however.

401K hardship withdrawal

If you do not want to pay the interest on a 401K loan, and you do not want to put your savings at risk, you may consider a hardship withdrawal. Again, these are not mandated by the government, so you will have to check your plan to see if you qualify. You will have to meet four conditions to be eligible:

1. You must have an immediate and severe need
2. You cannot get the funds elsewhere
3. You are only taking out enough to cover the need
4. You have already expended all of your loan options on your 401K

Once these conditions are met, you will only qualify if you are using the funds for one of five reasons

1. Buying a primary residence
2. Paying the cost of a tuition for you, your spouse or your child
3. Facing eviction
4. Miscellaneous severe financial hardship
5. Medical expenses

Hardship withdrawals are subject to taxes and a 10% penalty. You cannot return the funds to the account once they have been dispersed to you. This means you will permanently lose the ability for tax-free growth on the investment. You will essentially be losing an additional .30 to .50 cents of funds for each dollar you take out. Ultimately, hardship withdrawals make poor financial sense unless you have no other option to prevent a financial disaster.

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When can I withdraw from my 401K?

A 401K retirement plan is a specific, legal structure. Unlike a normal savings account, your 401K account is monitored by both your employer and the IRS. Whenever you make changes to this account, including withdrawing funds, you must do so according to the laws governing your account.

There is a minimum withdrawal age

Both the federal government and your employer provide you with the ability to have a retirement plan in order for you to save for the time you are no longer working. The advantages they offer, such as 401K contribution matching and tax-free contributions, are an incentive for you to save appropriately. This lessens the burden of social security and other needs you may have when you are no longer able or willing to work. The situation is a win-win for those involved; the government loses, though, when you withdrawal early. To stop you from doing this, the IRS sets a minimum age for withdrawal. This minimum age is 59 1/2 years as of 2009. Anytime you withdraw from your account or change your account, you will be subject to a penalty.

You pay a 10% penalty for withdrawing early

The standard penalty for early withdrawal from your 401K is 10%. The 10% is taxed only on the funds you withdraw. However, this can amount to a large loss if you take out a lot of money or make frequent withdrawals. There are some options to avoid the penalty. One option is to borrow against your 401K. Some lenders will accept the money in your 401K as collateral on a secured loan. When you do this, you do not forfeit those funds unless you default on the loan. Borrowing against the funds can supply you with the cash you need in the short run while protecting your retirement savings in the long run. You should be careful when borrowing against savings, though, because you can lose the money in your account and owe taxes and fees if you do default on the loan.

You pay taxes on your withdrawals

Any time you take funds out of your 401K, whether you are withdrawing early or after you have reached the minimum retirement age, you will have to pay taxes on the funds you take out. You did not pay taxes on the money when you placed them in the account, and this means you will have to pay the taxes on a deferred basis. So, if you withdraw early, you will pay the 10% fee plus 20% in taxes, or 1/3 of the monies you are taking out. To cover a $3,000 expense, you will have to take out $4,500 from your retirement savings. You should be careful with this rule when you are rolling your funds into a new retirement account. If you have the funds given to you in the form of a check before they are deposited into your new account, you will have to pay the tax penalty. Instead, it is important to move the funds directly into another retirement account instead of into your name.

Tags: 401k early withdrawal, 401k early withdrawal penalties, 401k withdrawal options, when can i take money out of my 401k

401k to Roth IRA Rollover

If you choose to move money out of a 401K plan, no matter where it is going, you will have to face tax consequences. This is particularly true when you are rolling over into a Roth IRA, because a Roth IRA uses after tax dollars while 401K dollars are not initially taxed.

Avoiding tax penalties

You will have a narrow window of time to avoid these penalties. Once your company sends you a check for the funds in your 401K, you will have to pay taxes on the funds. 20% of your 401K balance will be due in taxes as soon as the check is cut. Instead of choosing this option, it is better to roll your funds into a new 401K or a traditional IRA to avoid tax penalties. Traditional IRA accounts do not assess taxes on contributions prior to their withdrawal. Even if you are planning on keeping the money in a new traditional IRA, you will owe the 20% plus an additional fee of 10% for the early withdrawal.

Setting up a direct rollover is the only way to truly avoid paying the big tax bill and penalties. Instead of receiving a check personally for your 401K funds, you will need to have the check made out to the new retirement account. Your new advisor should be able to provide you with exact instructions to do this. You will have about 2 months to deposit the check into your new account.

Paying taxes to elect a Roth IRA

If you are moving your funds into a Roth IRA, then there is no way to totally avoid the tax penalty. This is because your 401K was based on a deferred tax structure, allowing you to only pay taxes when you withdrew from the account. Your new Roth IRA is different, and it requires you pay the taxes up front. You will only be taxed once on this plan. However, if you have a large lump sum, you should be careful to avoid moving into a higher tax bracket.

If you are considering using funds from your 401K rollover to cover the tax charges, think again. When you do this, you are penalized the 10% fee for an early withdrawal; as of 2009, you cannot begin withdrawing until you are 59 1/2 years of age. Anytime you take funds out of your 401K before that age, you will have to pay the 10% penalty. The good news is: there is no penalty for withdrawing early from your Roth IRA. However, the funds in your Roth IRA are allowed to grow tax-free. You are only taxed once, at the moment you receive the funds as income from your employer, and then they are allowed to continue earning money through investments without counting toward your income each year thereafter. If you take the money out of your Roth account and place them elsewhere, you will not be able to capitalize on the tax advantages of leaving the funds to grow.

Tags: 401k basics, retirement plan taxes, roth ira

Roth IRA vs. 401K: Which is better?

The Roth IRA option has become popular over the previous years owing to some advantages over the 401K retirement plan. However, both options are essentially good choices to save for retirement. Depending on your strategy and your family’s strategy, one option may have advantages over the other.

Key differences

There are a few fundamental differences between these two options. First, a Roth IRA allows individuals to contribute post-tax dollars, meaning you will already be assessed an income tax on the  money you contribute. Once you retire, since the funds have already been taxed, you will not have to pay taxes on your withdrawals. 401K plans are the opposite: no taxes up front, but you pay taxes when you withdraw. Other differences include:

• 401K has higher contribution limit
• 401K has minimum retirement age, Roth does not
• 401K has mandatory withdrawal period, Roth does not
• 401K plans force you to stop contributing when you leave your employer, Roth does not

Scenarios for advantages

Tax bracket changes

Depending on your expected taxes, you will be able to decide which option may be better for you. A young professional with a low income may be taxed at a low rate early in their career and a higher rate later. In this case, you will likely save on taxes if you invest in a Roth IRA. You will likely max out your contributions to a Roth IRA rather quickly, and then you can contribute other funds into a 401K after this point. In the end, you will still save on taxes over time. It is easy to aim for the 401K at a young age because you will be tempted to take the tax-free option. Long-term, however, paying the taxes now makes more sense.  The whole point of investing in a 401K or Roth IRA is to think long-term. These funds will not be used within the next 5 or 10 years, they are yours to use as you leave the workforce and aim to have the retirement you have planned for your entire life. As taxes generally trend in the upward direction each year, paying the taxes now simply makes better long-term sense.

Employer contributions

Your company may offer to match contributions to a 4091K plan up to a certain amount. Investing anything less than that amount is essentially throwing away paychecks each year. For example, if your employer offers a 6% match on your 401K contributions, then you can increase your salary by 6% on any given year just by saving money. If you are making $60,000, that 6% is $3,600 each year in extra funds. This amounts to an extra $75 each week you work, or nearly a half a day’s work. Your employer considers a total compensation package when determining your salary each year. This includes benefits like medical care and retirement plans. When you elect to forego one of these benefits, you are willingly lowering your compensation. Your employer will not offer to simply give you this money in cash each year; you will have to completely turn the funds down if you do not place the maximum contribution in your 401K.

Tags: 401k basics, retirement plan taxes, roth ira

401k Retirement Plan: Disadvantages

401K plans offered by your employers provide you with an option to set aside pre-tax dollars to support your retirement. These contributions grow both through employer-matching and through smart investment. Many people do not see the downsides to 401K contributions, but there are a few key disadvantages to be aware of.

401k plans are not flexible

Your 401K plan is governed by two separate sets of rules. The first is set by your employer. Your employer will set a maximum contribution amount and a maximum match amount. The contribution is how much of your paycheck can be allocated to your 401K savings each month. Your match maximum is how much your employer will additionally put into your account each year. Essentially, you will never be able to exceed these numbers, and you will not have ultimate control over how much you deposit. The government also sets similar requirements each year. There is a maximum yearly deposit any person can make; in 2009, this maximum is just over $16,000.

Aside from these limits, you will also be told if and when you can withdraw monies from your savings. If you deposit money into a traditional savings account, you can use the funds in case an emergency occurs prior to your retirement. If you have to use your 401K funds, you will face a penalty for withdrawing any funds prior to retirement.

401K funds are not self-managed

Your company will elect a financial planner to manage 401K funds on its behalf. If you are self-employed, you may elect your own 401K financial manager. Most people, though, have to go along with the choices of their employer. This means someone you did not meet with, choose or possibly do not even know will be making the decisions on how to invest your hard-earned dollars. Many people are okay with this, but you may not be. All you will receive is a statement on a monthly or quarterly basis telling you if your fund has grown or shrunk. You will not be able to ask questions about the financial decisions, and you will not be able to leave your financial advisor if you are dissatisfied. These decisions are made at the employer-level, and you have to go along with the decisions of your executive committee if you want to use the 401K option they provide.

Not all 401K dollars are safe from bankruptcy

If you contribute to a 401K plan with your employer, you could lose some of your funds if the company goes bankrupt. Thankfully, all contributions made before the bankruptcy will be protected. Unfortunately, though, if your deposit has not hit the account yet, it will be at risk. It can take up to 15 days for these funds to be deposited. Further, your employer does not make contributions on a regular basis. Many companies will do this semi-annually or quarterly. If this contribution match has not hit your account before the bankruptcy, then it will be lost to creditors in the bankruptcy filing.

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401K Retirement Plans: Advantages

When you are considering how to plan for your retirement, you should consider contributing to your company’s 401K plan. A 401K is a retirement savings plan offered by a number of different corporations with the help of financial companies. There are some basic facts to understand about a 401K in order to weigh the choice against other retirement savings plans.

401K Contributions are Tax Free

The main advantage to electing a 401K plan over other savings options is the benefit of tax deferral. Tax deferral simply means you are not paying taxes on the funds until you take them out of the account. With a savings account, you are placing funds into a bank or other location after they have already been taxed. You are then taxed as those funds continue to grow on your earnings. With a 401K, you are placing pre-tax dollars into the account. You will not have to pay taxes on this money until you take it out of the account, meaning it will continue to grow, tax free, until you need to use the money.

401K Contributions may be Employer Matched

Your salary as an employee is more than just your monthly paycheck. A salary is a combination of pay, benefits and other office perks. Benefits include healthcare and dental coverage. Other benefits may be a car allowance or paid parking. One of the biggest benefits offered by your employer is likely a 401K match option. When you elect to place a portion of your pre-tax salary into a 401K provided through your company, your company may match up to a certain percentage of that money. Typically, a company will match between 3-10% of a 401K contribution. This is extra money your employer is willing to pay you each month, and if you do not contribute the maximum amount, you are simply leaving the money on the table. With a 401K, you can raise your salary up to 10% each year by simply withholding pre-tax dollars from your paycheck. Individuals who elect not to use this option are turning away valuable funds each year.

401K Funds are Protected

Even if your company  goes bankrupt, your retirement savings may be partially protected. Any contributions you made prior to the bankruptcy declaration should be protected. Fully vested contributions from your employer will also be protected. There are only a few circumstances that will lead to a loss of funds with bankruptcy. First, you may lose the funds if your employer has not deposited them prior to declaring bankruptcy. The government mandates your employer to make the contributions as soon as possible, and they are usually deposited within 15 days. Typically, only one paycheck’s worth of contributions would be affected in this situation. Second, your employer may not have made a contribution match to your fund yet. Your employer does not match funds every paycheck. Instead, most companies make the contributions quarterly or even annually. If the deposit has not been made, then those funds may be seized in a bankruptcy filing, and you will not benefit from the contributions that have not been made.

Tags: 401K advantages, 401k advice, 401k basics, 401k rules