My sister made an offer on a condo last night and got accepted. She's figuring out the finances now and is considering a 401K distribution.
I believe its subject to income tax and 10% penalty for the withdrawal.
Anyone have insights on whether a loan against her 401K is a better idea, or even a home equity loan.
I've always been taught to avoid distributions and penalties, and figure any loan she would take would be a better way to go. But I don't know much about house financing yet, and thought maybe some of you had looked into this...
Thanks
Lisa Rose
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Re: 401K loan or distribution for downpayment?
I took 10K out of my 401K as part of our down payment. I had to pay taxes on it but because we were first time homebuyers, we did not have to pay the 10% penalty.
Meg9-20-02
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Re: 401K loan or distribution for downpayment?
We had a big meeting here at work about this yesterday - a rep from JP Morgan came in. He said taking a loan from your 401K is a terrible idea. You pay tax on it when you withdraw it and then have to pay tax on the money that you use to pay it back. He claimed that any other loan - even a straight loan from the bank or a home-equity loan are much, much better. If either of those are an option, I'd recommend doing that.
michele31
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Re: 401K loan or distribution for downpayment?
Unless you HAVE to, you shouldn't play with that money IMO. If it is just going to lower her mortage a bit, I would leave the money alone. She also needs to speak with your 401K plan administrator since not all of the money is allowed to be withdrawn, There are a lot of rules about this stuff.
ddunne23
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Re: 401K loan or distribution for downpayment?
We borrowed a couple of thousand from DH 401K to help us out a little and he has not penalties associated with doing so. Definately look into it as every company is different. He has automatic deductions from his payroll to pay it back with interest. But you are paying yourself the interest since you are borrowing your own money. Only drawback is if you leave the company before it is paid off, you have to pay it back immediately or else their will be tax consequences, because it is then looked at as a withdrawal rather than a loan.
LisaT
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Re: 401K loan or distribution for downpayment?
Meg, I've read that funds obtains from a 401K loan are not subject to income tax or the 10% early withdrawal penalty (unless the loan defaults). But you are paying it back with taxed money, and then will get taxed again on the retirement distributions.
There are generally four reasons given to avoid 401k loans:
1-Lower investment return. According to the General Accounting Office, the interest rate paid on a plan loan is often less than the rate the plan funds would have otherwise earned. 2-Smaller contributions. Because the participant now has a loan payment, they may be tempted to reduce the amount they are contributing to the plan and thus reduce their long-term retirement account balance. 3-If the participant quits working or changes jobs, the loan must be pay back right away. It's not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If the participant can't repay the loan, it is considered defaulted, and the paricipant is taxed on the outstanding balance, including an early withdrawal penalty. 4-The participant has done their work to determine their retirement goal and pick the right investment mix. But when they take a plan loan, money must be removed from existing plan investments. If plan loan amounts must be taken money from the equity investments within the plan, it could diminish the long-term overall investment return.
Thanks for all your responses. I've definitely got her thinking now...
shelzyp
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Re: 401K loan or distribution for downpayment?
Loans are not included in income!!
If you take a deistibution, you can take 10,000 without the 10% penalty but you ahve to pay the taxes.
When you take a loan you are paying yourself back interest.
Fran M
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Re: 401K loan or distribution for downpayment?
A loan is definately the way to go vs. a distribution due to the penalty & tax liability. With the 401(k) loan the interest paid is put back into your account but it is not deductible. One big caution - if she plans to leave or has to leave her company prior to the loan being paid back she will have to pay it off, usually withing 30 days or it will be treated as a distribution and subject to the tax and penalties.
With interest rates being so low today she can probably get a better deal on a Home Equity loan. Home Equity interest is probably deductible.
I know that we are talking about 401ks...but for public employees you can take a loan out of your retirement fund without penalty and at 1 % interest I think...( a coworker did this to psay for her daughters wedding)
bride082003
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Re: 401K loan or distribution for downpayment?
we took a loan out of our 401K after we bought a house and did not pay any taxes on this. We chose this option over just regular loan or equity line of credit because we pay ourselves back the interest. We have since paid it off. And you have to check on this, but I think with most companies if you lose your job/quit you have it pay it back ASAP or pay taxed on it which can be up to 30%. I have heard many people say they have borrowed against it for down payments....
