401k

[DTS]

A client of mine will be leaving his current employment and moving South to a new business. He has a 401k worth about $90,000. He would like to buy a home with this when he arrives at the new location.

I would like to tell him best thing to do is a trustee to trustee transfer to the new company, if they permit this. Also, according to the rules, he could borrow 50% and repay this amount over 5 years to the new company.

Two questions:
1) Is the 5-year rule a given or are there cases where this can extend over a longer period?
2) Can he also take an additional $10,000 lifetime max. for home purchase, penalty free from the remaining $45,000?

Thank you, Dennis

[Gene V]

Dennis, This is all from memory, but I’m sure someone will correct me if I’m wrong.

The rules for the company that I worked for was you could borrow up to 50% and you had a minimum of one year and maximum of 5 years to pay them back.

The $10,000 lifetime maximum withdrawal applies to IRAs not 401K

Gene

[S T]

401 K Transfer

Dennis, Gene is correct,

Taxpayer should inquire at the new employer for their rules and waiting periods after the 401k transfer from old employer to new employer. He probably does not want to borrow from the 401K at the employer that he is leaving, as the loan possibly could be due upon termination of employment. Taxable event if the taxpayer can not repay in full at the time of employment termination.

If the taxpayer can transfer the 401K plan to the new employer, and the new employer rules will allow him to borrow from the 401K plan, he should have 1 year to 5 years to pay back through payroll deduction.

The $10,000 rule for withdrawal , 10% penalty free only "not tax free" applies to IRA accounts not 401k accounts and it is for first time home purchases, taxpayer must not have owned a house in the prior two years. Also the $10,000 has a Lifetime Cap.

See your reference material at page 14-1, footnotes.

Sandy

[Snaggletooth]

The REAL advice

Hey Dennis, if you want to give this guy some REAL advice, tell him to leave his retirement alone. If he doesn't want to raise the down payment, tell him to roll over $10,000 from his 401k into an IRA - then roll the rest of it into the 401k of his new employer. $10,000 (or some lesser amount) can then be used as a down-payment.

I'm amazed at how my clients will use any excuse to raid their retirement money. They just can't stand to have money "laying around" without spending it. When they really do retire, they won't have "jack."

[Lion]

401(k)

He can do a trustee to trustee transfer of $10,000 from his 401(k) into an IRA and withdraw it from the IRA without the 10% penalty but with ordinary income tax IF he's a first time home buyer, hasn't owned a home for two years. But, why trash his retirement for a home he can't afford? He can't replace money in his IRA; those prior year contributions are lost forever once he withdraws. If you really want to give him good advice, advise him to buy a home he can afford from his cash flow.

He needs to talk with his new employer's 401(k) plan administrator immediately. There are as many plans as there are companies. He needs to find out if and when he can transfer from his old plan. Then he'll do a trustee to trustee transfer. He needs to find out if he can borrow from his new plan and under what circumstances. Probably a percentage limit as well as an absolute dollar limit. And, he needs to find out the terms for borrowing for home buying. Sometimes the five year limit is for all borrowing except principal residences; sometimes the plan will include ten years or longer or matching his first mortgage time or 30 years or ... when borrowing to purchase a principal residence. He should read the plan himself and not just the summary. Again, if he gets laid off or otherwise separates from his new company, he's responsible for all loans from his 401(k) immediately or they become fully taxable distributions.

It's dangerous to borrow from a 401(k). I've seen it used for a bridge loan and repaid within 60 days. But, to trade retirement for a bigger home now is not fiscally responsible. Hope he's single and not supporting a family. Bet he doesn't have some liquid savings as an emergency fund, either. Tell him to buy a good book on budgeting.

[DTS]

Thanks for the good advice

Thank you all for responding. There is some very good advice in your responses!

After I read Gene's response last night about the $10,000, I thought I would mention to the client to rollover this amount to the IRA then use for the downpayment, which was suggested in later posts. Unfortunately, in CA, a downpayment of $10,000 will not get you very much so the client will have to tap more of his retirement.

I will talk to him and tell him all you have suggested. Also, I have told him to check with the future employer about all the rules that will allow him or not, to use this money.

Dennis

[DTS]

Lion, I wanted to ask you

And, he needs to find out the terms for borrowing for home buying. Sometimes the five year limit is for all borrowing except principal residences; sometimes the plan will include ten years or longer or matching his first mortgage time or 30 years or ... when borrowing to purchase a principal residence.

Rita,

I forgot to ask you before about this section of your response. Where did you find this? Was it in a private administrative plan you saw or was involved with personally or in a publication I can look at to investigate this matter further?

Thank you, Dennis

[Armando Beaujolais]

Please excuse me for jumping in here, I'm not presuming to speak for Lion.

The terms laid out in IRC section 72(p)(2), "Exception [to loans treated as distributions] for certain loans" state that the maximum loan amount is $50,000, the loan cannot be more than 1/2 the balance, the loan must be repaid in equal installments at least quarterly, and a home loan for a principal residence does not fall under the 5-year rule.

If a plan allows the loans, the actual terms, payment periods, interest rates, default rules, etc., will be established by the specific plan itself, not by the IRC. Different plans have different terms, if they allow loans at all.

You'll need to check with the plan's administrator.

[Lion]

Armando said it

Armando took you to the heart of the matter. Including the part about each plan making it's own rules. I was remembering the IRS basics (probably from a course in retirement plans) but also how any plan can work within what the IRS allows and how different plans can be. I worked for one small firm and was administrator of their plan, very boilerplate from a company that qualifies plans for you, that allowed home borrowing for 30 years (I think; it was a very long time ago). My husband's 403(b) at school allowed for ten years. His 403(b) at church doesn't allow any borrowing for any purposes, I think. Similarly, companies create their own matching rules or don't match at all.

Definitely, have him read the full plan document and maybe get a set of sample loan documents.

Personally, I'd suggest he really think about what he's doing if the only way he can afford a home is to gut his retirement plan. There's always the risk he won't pay back his retirement funds. Maybe, he could leave his 401(k) alone but not contribute any more for a short while to increase his take-home pay while he saves for a house. But, then he risks missing years of retirement savings and even not returning to saving for retirement. He needs a financial planner to help him map out his big picture and not just jump from one thing to another. Is he thinking of taking out HALF his retirement plus $10,000 or just a tiny percentage? He needs some liquid savings before he invests in a house (and if he had any liquid savings, he'd use some of it for a downpayment instead of dipping into his retirement). You can tell him the tax consequences of his options, but he shouldn't make a major decision like home buying for the tax consequences alone. And, it's mid-July; his tax savings this year will be smaller than he thinks (than all his friends told him) so he'll be upset with you next April.... Good luck.

[DTS]

Armando and Lion

Thanks so much for your help. I will meet with this client sometime next week and will explain all this to him. Both of you have helped a lot.

Dennis