401(k) plans are long-term, employer-sponsored pension plans that offer tax advantages to individuals saving for retirement. If you are older than 59 1/2, you can withdraw from your 401(k) without penalty. Younger savers can rarely buy real estate with their pension plan. The Internal Revenue Service does, however, allow investors suffering hardship to withdraw funds before retirement age, and you can typically borrow from your 401(k) funds to buy property, subject to IRS regulations.
Borrowing Against Your 401k
Review your 401(k). Allowing loans from a 401(k) is permitted by law, but an employer is not obliged to do so. That said, loans are a feature of most traditional, safe harbor, simple and profit share plans. Check out your summary plan description, or talk to your 401(k) plan administrator.
Calculate how much you can borrow. The government restricts borrowing to $50,000 or half the value of your plan, whichever is lower. You'll pay interest on the loan but, as long as you pay it back, the loan amount is tax-free. Some plans impose a minimum loan amount.
Review the loan repayment terms. While larger employers may give you 15 years to repay the loan, some plans give you just five -- making your monthly payments substantial. The bank will take your 401(k) loan payments into account when assessing your mortgage qualification. Typically, you'll repay the loan through deductions from your paycheck.
Establish the interest rate you will pay. Interest rates vary by plan. The rate most often used is the interest rate banks use as a reference point for loans, known as the "prime rate," plus 1 or 2 percent. You can find the prime rate in the business section of newspapers such as the Wall Street Journal.
Rolling Over Your 401k
Check the terms and conditions of the Individual Retirement Account where you want to roll your 401(k). Some IRAs permit you to withdraw funds without notice, penalty or tax. You cannot, however, roll over your 401(k) with a current employer, so you'll have to utilize funds from an old scheme.
Gather together your 401(k) paperwork and have your account and reference numbers on hand. Telephone your IRA provider and tell them that you want to roll your 401(k) assets to your IRA. You may be able to do this over the telephone. Otherwise you will complete an account transfer form either on paper or online.
Check that your request has been processed. As soon as you make the roll over request, your IRA provider will contact your 401(k) provider and execute the transfer. This may take a week or two. Once the funds are in your IRA, you can use them within the limits of your IRA scheme.
The IRS permits investors to withdraw funds before retirement age if they can show an urgent and heavy financial need -- in some plans, this includes purchasing a primary residence. On the downside, it's costly. You'll pay income tax at federal rates, together with state taxes on the withdrawal. You'll also pay a 10-percent penalty.
Borrowing against a 401(k) will create monthly payments that increase your debt-to-income ratio, which in turn will affect your ability to get a mortgage loan. Some lenders will not permit you to use your 401(k) as a down payment. The major risk of a loan is that if you move companies or lose your job, you're obligated to pay back the loan within 60 to 90 days. If you can't, the loan amount is treated as a hardship withdrawal, with its incumbent tax and penalties.
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