How to Purchase a Home Using a 401k

A 401(k) loan can help buy a home without incurring early withdrawal penalties.
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The Internal Revenue Service rules permit you to take a distribution from your 401(k) plan only if you're over age 59 1/2, have a severe financial hardship or have stopped working for the company that sponsors the 401(k) plan. Even if that includes you, you may incur taxes and penalties on a distribution. Alternatively, you may be able to use a 401(k) loan to help you make a down payment on a home, including land to build a home, or pay off your mortgage.

Hardship Withdrawals

Even if you're still working for the company and you're under 59 1/2, you might qualify for a hardship withdrawal from your 401(k) plan to purchase a home. According to the IRS, 401(k) plans can, but aren't required, to allow for hardship withdrawals. In addition, the plan can limit hardship withdrawals to specific types of hardships, such as a medical emergency, and exclude other hardships, like purchasing a home. Therefore, you must check with your 401(k) plan administrator to see if you qualify. A hardship distribution is limited to the amount necessary to relieve the hardship, plus any taxes and penalties on the distribution. For example, if you are able to purchase a home with a 10 percent down payment, you couldn't take a hardship withdrawal for 100 percent of the purchase price. Your 401(k) plan administrator will tell you exactly what information the IRS requires you to provide for a hardship distribution when you fill out a hardship distribution request form, available from your plan administrator.

Taxes and Penalties

Your distribution from your 401(k) plan counts as taxable income, regardless of your age, and is taxed at your marginal tax rate. If your distribution pushes you into a higher bracket, only the portion of your distribution that falls in the higher bracket will be taxed at the higher rate. For example, if you're in the 25 percent tax bracket, your 401(k) distribution will be taxed at 25 percent (unless it pushes you into the 28 percent tax bracket, in which case only the portion falling in the 28 percent bracket will be taxed at the 28 percent rate). If you are under 59 1/2, you must pay an extra 10 percent tax because your distribution isn't a qualified withdrawal. Even if you're taking a hardship withdrawal, the penalty still applies.

Loan Alternative

You might be able to use a 401(k) loan, rather than a withdrawal, to assist in purchasing a home. According to the IRS, 401(k) plans can permit loans of up to $50,000 or half your vested account balance, whichever is smaller. Your vested balance means that amount you would keep if you left the company today. For example, if your employer has made contributions that require you to work for a few more years, those don't count. The loan can be taken for any reason, but if you use the proceeds to purchase a primary residence, your 401(k) plan can offer a repayment period of up to 10 years. For any other purpose, the loan must be repaid over five years. To take out a loan, complete a 401(k) loan request form that requires your account information, the amount you want to borrow and, if you're requesting a period longer than five years, proof that you are purchasing a primary residence, such as a copy of the signed contract for the property.

Loan Terms

A 401(k) loan will charge interest and must be repaid with payroll deductions over the term of the loan. Though you will miss out on having the loan amount invested in the market while the loan is outstanding, the interest will be credited to your account. If, however, you leave your employer before you repay the loan, you must repay the entire amount at that time. If you fail to repay the loan, the remaining balance is treated as a distribution from your 401(k) plan. That means it counts as taxable income and, if you're under 59 1/2, it is also hit with a 10 percent early withdrawal penalty.