Your 401(k) acts as a powerful savings platform throughout your working years. With the opportunity to receive contributions from your employer in addition to any deposits you make personally, your 401(k) account can act as a valuable financial resource as you approach your retirement years.
You can use a variety of methods such as 401(k) loans and IRA rollovers in order to successfully make payments on a home mortgage using 401(k) funds.
Exploring the 401(k) Basics
By design, your 401(k) account is intended to act as a retirement savings account, allowing you to accrue the funds you will need to maintain your lifestyle during your retirement years. Because of this, it should come as no surprise that the IRS expects individuals to refrain from withdrawing money from their 401(k) until they reach the age of 55 at the earliest. Early withdrawal penalties are often assigned when individuals commit to withdrawing funds from their 401(k) prior to this time. Aside from this particular regulation, very little oversight is dedicated to how you choose to use the money in your 401(k).
Use Caution With 401(k) Withdrawals
For some individuals, these funds can be used to help fund a mortgage payment. If you are planning on taking money out of a 401(k) for house payments, you must ensure that your regular withdrawals do not incur penalties. Failure to ensure penalty-free withdrawals could cause you to lose a significant amount of money that you have saved throughout your working years.
The good news, however, is that safeguarding your 401(k) funds doesn't have to be a complex process. In fact, the IRS clearly dictates the specific rules and regulations an individual should follow in order to ensure that they don't incur penalty on their 401(k) withdrawals at any point. By any standard of measure, the rules and regulations surrounding 401(k) withdrawals are quite transparent.
401(k) Withdrawal for House Payments
If you are planning on withdrawing money from your 401(k) to fund a mortgage before you turn 55, it is almost inevitable that you will be forced to pay a 10 percent withdrawal penalty on all distributions that occur before you reach this age. Not only will you be required to pay this penalty, but you will also be forced to pay income tax on the entirety of the distribution, including the principal you have already invested. Unless you are planning on funding these mortgage payments after the age of 55, you will likely need to come up with an alternative solution.
Roth IRA Withdrawals for Mortgage
One such "fix" for this issue is an IRA rollover. For example, if you are also managing a Roth IRA account in addition to your 401(k), you should be able to complete a rollover of funds from your 401(k) into this account. Given the fact that Roth IRAs allow you to withdraw your personal contributions at any time without penalty, this rollover process will effectively ensure that you can withdraw the amount you need for your mortgage at any given time without penalty. That being said, it is important to note that funds traveling from a 401(k) to a Roth IRA will be subjected to income tax prior to completing the rollover. This is due to the fact that all funds being placed in a Roth IRA are subjected to taxes before the contribution is made.
First-time Homebuyers and Traditional IRA
A traditional IRA rollover can also be an excellent option, although you will likely not receive as favorable tax treatment as you would with a Roth IRA. According to IRS guidelines, individuals can withdraw up to $10,000 from a traditional IRA for costs associated with purchasing your first home without fear of penalty. If you are married and your spouse also has a traditional IRA, they can withdraw the same amount as well, effectively doubling your available funds to $20,000. Unfortunately, however, these funds will still be subjected to income tax due to the fact that the funds were contributed to the IRA before any taxes were paid on them.
Although IRA rollovers are an excellent strategy for avoiding unwanted penalties, it is probably still in your best interest to keep as much of the funds originally stored in your 401(k) in this account to take advantage of the earnings it provides. With that in mind, you should carefully evaluate how much money you will need to pay your mortgage and transfer only this amount to your IRA. If payments will be recurring, you may choose to transfer several months worth of funds at one time.
401(k) Loan Mortgage Payment
Yet another method to withdraw from 401(k)s for house payments is via a 401(k) loan. You are legally entitled to borrow up to $50,000 or half the value of your current 401(k) account, the final borrowing limit being the lesser of these two values. Although you will be required to pay back these funds, experts agree that a 401(k) loan is still less expensive than direct withdrawal from the account itself. Keep in mind, however, that if you take out a 401(k) loan and then leave the company through which your account is maintained, you will likely be required to pay back the loan balance within three months. Failure to do so could result in severe fines and penalties.
Moving Ahead With Your Plans
Regardless of which method you choose to fund your mortgage, you should research all of your available options carefully and ensure that you are striking the appropriate balance between short-term expenses (your mortgage) and long-term financial health (your retirement). The inherent value of an account such as a 401(k) or IRA is the fact that funds are allowed to grow in a protected haven for years and, in some cases, decades. Although removing funds from your 401(k) to pay your mortgage bills will certainly serve your interests in the short term, it is worth taking the time to fully assess whether or not you may be compromising your future retirement security by doing this.
Consult a Professional
Of course, there is no "right" answer when it comes to the tools you use to satisfy your mortgage requirements while simultaneously preparing for retirement. That being said, it may be worth your time to consult with a financial adviser or retirement planner in order to uncover other payment strategies that you may not have yet explored. If withdrawing funds from your 401(k) does turn out to be your best option, a financial adviser or tax professional can help ensure that you successfully avoid the myriad of fines and penalties that could occur following a careless withdrawal. The stiff penalties associated with such withdrawals should act as a huge deterrent for most individuals.
Whichever method you choose to use, always ensure that you keep careful documentation of your activity for IRS purposes. When the time comes to file your tax return, this documentation will help ensure that you complete all relevant paperwork correctly and in an error-free fashion, sparing you the headache of IRS intervention at a later point.
Items you will need
- IRS Form 1040 or 1040A
- IRS Form 5329
- You can get a loan from your 401(k) plan to purchase a home. There is no tax or penalty as long as you pay it back on time. Some people take this route, especially if they you do not qualify for a hardship withdrawal. Beware, however, of the following possibility: if you leave the job -- including getting laid off through no fault of your own -- you must usually repay the loan either immediately or within 60 days, depending on the terms of your loan.