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I currently have a 401k from a former employer with $28,000 vested. I am looking for recommendations on the best way to withdraw this money with limited tax liability. My wife and I will be buying our primary residence shortly and would like to use this money for a portion of our down payment.

I know it's not the best long term financial decision, however, living in CA I want to take advantage of low prices and interest rates.

Thank you in advance for your replies.

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Many employers now let you continue to pay on a 401k loan after you have left the company. My employer will give you a c... (more)

cristinaaaron (Oct. 12, 2012 @ 4:29p) |

My employer also has Fidelity and doesn't force you to pay off a 401k loan at termination. You can continue to pay the... (more)

jerosen (Oct. 12, 2012 @ 5:31p) |

Do it. I live in CA and had to do the same thing. If you actually do your homework, you'll find out that you'll have 2 o... (more)

mrevanward (Oct. 31, 2012 @ 3:53p) |

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Withdrawing from a 401K is not a good idea. You will be hit by a penatly (10%) and have to pay taxes on the withdrawl. If you have to do this, then you cannot afford to buy a house.

You can rollover the 401k into an IRA, with no taxes or penalty.
Then you can withdraw 10,000 to purchase a home, which is taxable, but avoids 10% penalty
More detailed information

It will vary depending on your tax bracket for the year, but you can assume about half of it will be gone after the 10% penalty and taxes. I assume no one will convince you not to do it, so just make sure you keep enough money aside to pay your tax liability.

you can roll over to new company 401k and borrow against it

yes roll over and borrow against it, you will be paying yourself back with interest.

If you already have a Roth IRA, withdraw your original Roth contributions tax and penalty free. If you like, you can then rollover your 401k to a rollover IRA, and convert to Roth to replace what you withdrew and use to purchase a bigger and more expensive house 5 years from now.

If you borrow against your 401k for your down payment, you may have to document that on your mortgage application, which will increase your DTI which will decrease the mortgage amount you can borrow.

Edit: I don't recommend doing this, but since OP asked how to shoot himself in the foot and seems to understand the financial implications, this method provides a tax efficient way to shoot himself in the foot.

mogg said:   If you already have a Roth IRA, withdraw your original Roth contributions tax and penalty free. If you like, you can then rollover your 401k to a rollover IRA, and convert to Roth to replace what you withdrew and use to purchase a bigger and more expensive house 5 years from now.

If you borrow against your 401k for your down payment, you may have to document that on your mortgage application, which will increase your DTI which will decrease the mortgage amount you can borrow.


Decreasing the amount he can borrow is a GOOD thing, since he clearly can't afford what he wants if he's robbing his future to live beyond his means today!

I suppose I can not judge. I have no issue of robbing my 401k prior to retirement age. Then again, medically speaking, there is no way for me to be alive when I hit retirement age. My family is provided for in the form of a multi-million dollar life insurance policy, so if we needed/wanted to use the 401k early I see no problem with it.
I assume however, this is not the case with OP.

"living in CA I want to take advantage of low prices and interest rates." Seriously??
But anyways, is there anything there which is Roth 401K? Because that you can always withdraw tax free. In that case, you only have to pay tax on the profit you've made on it.

T0ol said:   yes roll over and borrow against it, you will be paying yourself back with interest.
Make sure to call your current employers 401k provider to make sure this is a viable option first before moving your money.

It is a standard 401k with my previos employer.

I know it seems like a random excuse, however, I want to be in home my wife and I can be in for a long time in a good school district for our two little ones.

Thank you for you reply.

Thank you everyone for the replies, I do know that I am shooting myself in the foot financially speaking, however, being 24 I feel like I have plenty of time to borrow from my 401k as suggested and pay it back without too much damage.

Don't forget that you can't borrow more than 50% from 401k. If you need more, borrowing is not an option.

ReformedCCCharger said:   Thank you everyone for the replies, I do know that I am shooting myself in the foot financially speaking, however, being 24 I feel like I have plenty of time to borrow from my 401k as suggested and pay it back without too much damage.
Being 24, you also have plenty of time to work hard and save $$ for a large down-payment on a house in the future.

That said, I was once that age (that seems like quite a while ago,) and no one could talk me out of anything, no matter how much experience and knowledge they had. But, I would be remiss if I didn't at least try. Worst financial mistake I ever made was buying a house *waaay* too soon (also at age 24, 1 year out of college) without any savings. I put a grand total of $1500 down (borrowed from my 1-year-old 401k) on a $140k loan!

I've got a friend who's best financial achievement was saving for 10 years and buying his house outright. I'll end up paying ~3X the value of my house over 30 years. He paid 1X in 10 (+ cheap apartment living during the time.)

Now, both of those are extremes, I understand, but I'd try to err on the side of my friend, rather than on mine.

Work hard.
Do without.
Save.

That will make life *so* much better down the road. Trust me.

ReformedCCCharger said:   Thank you everyone for the replies, I do know that I am shooting myself in the foot financially speaking, however, being 24 I feel like I have plenty of time to borrow from my 401k as suggested and pay it back without too much damage.
One of the major ideas behind a 20% down payment out of pocket is that it shows you can save enough for this above and beyond your current expenses/savings for the future. I'm guessing your kids are young and so you also have plenty of time before they get to high school, which is when the school district matters even more.

Consider saving up the necessary amount first, then a safety fund (how do bills get paid if someone loses their job?), and then go buy yourself a home. Despite it being opportunistic, there are certain risks that can send you back to 0, especially taking on debt that shouldn't be taken on.

In the meantime, you might be able to find a larger apartment in that area. My parents were well into their 30's and I was in middle school before we lived in a house and it wasn't a serious issue - I would be hard pressed to come up with any negative impact that may have had.

I'm 24 as well and I figure that I haven't seen as much in life as others. I haven't been laid off, I haven't had to go through a divorce, or anything else along those magnitudes. For this reason, I try and lean on the side of extra conservatism when managing liquidity (A house can be an asset, but it's easier to put money in than take out), because I don't know what's ahead.

DrXX said:   Don't forget that you can't borrow more than 50% from 401k. If you need more, borrowing is not an option.

After taxes and penalties he won't get more than a bit over 50% anyways.

If you found a house which you like and will stay in for a while, go ahead and buy it. It is a great time to do so from a market perspective. Prices are low, and rates are low. If your income is stable and you can afford the place you want, buy it. General rule of thumb is not to go over 25% of your gross income for your home. This includes mortage payments, home owner's insurance, property taxes, HOA fees, and maintenance/repairs. Also, don't forget your utility bills will likely increase (a bigger home to heat, might have to pay for water now, etc.). Avoid being house poor. Buy less house than you can afford. Live below your means.

What is your income level? How close are you to the next tax bracket?

Someone else mentioned rolling over into an IRA. That isn't a bad idea at all. If your taxes are low, you might want to consider rolling over into a Roth IRA. You would have to pay taxes on it now, but you can spread the tax hit out over a couple of years. Also, the tax benefit from being a home owner would help absorb the tax hit from the conversion. The advantage of a Roth IRA over an IRA is that all of your contributions are available to you since you have already paid taxes on them. I'm not saying borrowing against your retirement accounts for a home is a good idea, but that is your decision to make. If you leave the funds in your Roth IRA and you think your taxes will increase in retirement, doing the Roth conversion now would be a good idea (even without the house). Don't forget taxes will likely increase for 2013 as the Bush tax cuts are set to expire.

T0ol said:   yes roll over and borrow against it, you will be paying yourself back with interest.

This is not accurate.

You will have the money out of the market, which means you won't be getting interest... at all.

The fact that you "pay yourself back with interest" is some financial magician's way of getting people to use this money.

No matter how you look at it, taking a loan against your 401k is bad... unless... the use for the money will get returns over the projected long term average of the market AND the tax penalty AND any taxes you pay on the growth of that money based on your income bracket.

I would say these conditions are pretty rare.

SteveG

ankitgu said:   ...One of the major ideas behind a 20% down payment out of pocket is that ...
... but it's easier to put money in than take out), because I don't know what's ahead.


Ankitgu -

You have a good level of maturity at 24. Perhaps we can get you on the lecture circuit!

SteveG

Hi Public,

Thanks for the info. In terms of income I make 90k salary per year and my wife makes 76k per year. We both invest in our 401k's to the company match of 4%.

We are currently renting a home in So. California for $2,400 per month which we are very comfortable with and have been paying that for 2.5 years. We have roughly $60,000 currently saved and simply need to get to 80k-100k for a down payment.

In terms of tax bracket, I am not sure how close we are to the next bracket. Taxes are not my strong suit.

cKGunslinger said:   ReformedCCCharger said:   Thank you everyone for the replies, I do know that I am shooting myself in the foot financially speaking, however, being 24 I feel like I have plenty of time to borrow from my 401k as suggested and pay it back without too much damage.
Being 24, you also have plenty of time to work hard and save $$ for a large down-payment on a house in the future.

That said, I was once that age (that seems like quite a while ago,) and no one could talk me out of anything, no matter how much experience and knowledge they had. But, I would be remiss if I didn't at least try. Worst financial mistake I ever made was buying a house *waaay* too soon (also at age 24, 1 year out of college) without any savings. I put a grand total of $1500 down (borrowed from my 1-year-old 401k) on a $140k loan!

I've got a friend who's best financial achievement was saving for 10 years and buying his house outright. I'll end up paying ~3X the value of my house over 30 years. He paid 1X in 10 (+ cheap apartment living during the time.)

Now, both of those are extremes, I understand, but I'd try to err on the side of my friend, rather than on mine.

Work hard.
Do without.
Save.

That will make life *so* much better down the road. Trust me.


You don't say HOW MUCH each of you paid for your house. You might have paid 50k, while your friend paid 200k for same house, not taking into account different living conditions and costs for the 30 years. He paid rent, you didn't. Your house is probably nicer, although you did have different manintanance expenses.

Time is going to runout on low prices and low interest rates. There are houses selling for less than replacement cost of the house alone, meaning the current owner or developer is paying you to buy the land. Interest rates pretty much will go up after all this government intervention, especially 30 year mortgages. Current low rares might last a year or two, but 5 years from now, I believe lots of people will be looking back longing for the rates we have today. Timing investments is hard and often luck, but switching from bonds and stocks to real estate, even after paying a penalty might be a reasonable risk to take these days. Remember, buying a home with a loan is a heavily leveraged transaction.

ReformedCCCharger said:   Hi Public,

Thanks for the info. In terms of income I make 90k salary per year and my wife makes 76k per year. We both invest in our 401k's to the company match of 4%.

We are currently renting a home in So. California for $2,400 per month which we are very comfortable with and have been paying that for 2.5 years. We have roughly $60,000 currently saved and simply need to get to 80k-100k for a down payment.

In terms of tax bracket, I am not sure how close we are to the next bracket. Taxes are not my strong suit.


Your numbers are very good for your age. The fact that you saved 60k in a couple of years is impressive.

However, keep in mind that when you buy this new house, with 100k down, you will be out of money. No savings. No 401k to borrow from. You will have the mortgage and the 401k loan to pay back.

I am not saying you shouldn't do it... but you have two young kids. A medical problem, a loss of one of your jobs, etc. could put you in a situation where you need to sell this house, and it might take some time to do in this market.

And, who knows, the market might get even worse ... I don't think so, but you should always plan for the worst.

SteveG

ReformedCCCharger said:   Hi Public,

Thanks for the info. In terms of income I make 90k salary per year and my wife makes 76k per year. We both invest in our 401k's to the company match of 4%.

We are currently renting a home in So. California for $2,400 per month which we are very comfortable with and have been paying that for 2.5 years. We have roughly $60,000 currently saved and simply need to get to 80k-100k for a down payment.

In terms of tax bracket, I am not sure how close we are to the next bracket. Taxes are not my strong suit.


With that LOW level of contribution, you really should increase it. Should see tax deferment benefits. Maxing out should be your goal with your income.
How much are the homes you're looking at? How much down? Not taking into account down payment and PMI, PITI on 400k, 30 years 3.5%, 5k taxes, 1k insurance comes to less than 2300/month. Helps make the case you should buy. The challenge is to figure out how to bridge the budget gaps.

http://www.realestatepropertytaxes.com/PITICalculator.html

Just because interest rates are low, does not mean housing is a steal. I'd highly recommend checking out the NYTimes Rent vs Buy calculator to take a look at whether your current rent is a better or worse deal than owning in your neighborhood.
Link: http://www.nytimes.com/interactive/business/buy-rent-calculator....
You may need to modify their sale % cost/buy % cost which is often lower in CA than their default assumptions. 5% to sell, and 1-2% to buy are probably more accurate.

Everybody buys houses based on how much the monthly payment is. When interest rates are low, home prices are pushed up. When interest rates are high, home prices are pushed down. The key metric though, is the rent-to-buy ratio. You should figure out for your local neighborhood to see if it is over or underpriced.

You and your wife make $166k/year and contribute 4% to your 401(k)s. You didn't mention any other tax advantaged accounts, so your taxable income is $159.36k/year. That puts you in the 28% federal tax bracket ($142,700 $217,450) for married couples filing jointly. Your state income tax seems to be 9.3% for California. The federal rate will likely increase next year due to the Bush tax cuts expiring.

In order to get bumped into the next tax bracket, you would have to make $217,450/year. You likely don't need to worry about that. You have plenty of room to convert to a Roth IRA, but know that it will be taxed at 28% federal + 9.3% state (and that will increase next year if you split the tax hit across multiple years).

You are closer to the tax bracket below your current bracket, and you could lower your tax rate if you and your wife increased your retirement savings in your tax deferred accounts (401(k)s). You can both contribute up to $17k/year to your 401(k)s. Doing so lowers your taxable income by $34k (17*2) which would keep you out of the 28% bracket and in the 25% bracket. I think this would be a great thing for you to do, but again that's your decision.

The decision of whether or not to go with a Roth IRA is based on whether or not you think your tax rate now is higher or lower than the tax rate you think you will pay in retirement. If you think you pay a higher rate now (as with most people), it makes sense to wait to pay taxes in retirement for the lower rate. This means utilize a traditional 401(k) or traditional IRA. If you think your tax rate will increase in retirement, it makes sense to pay taxes now while you have the lower rate. This means utilize a Roth 401(k) or Roth IRA. Nobody knows what will happen 30 years down the road. There are too many variables for that, but you can make your best guess and go with your gut/common sense.

You're a high earner now, so your tax rate is high. I don't know how stable your career is or how much room you have to be promoted/increase your earnings, so I don't know how your career might affect your tax rate. Given that you are already in the 28% bracket, I probably wouldn't pay 28% (plus 9.3% to the state) on the $28k in the 401(k) to get it into a Roth IRA. Which leaves the traditional IRA option. With this option, you would be limited to taking out $10k for a home. If that plus the $60k is enough for your down payment, I'd go with that.

If you are okay with paying the taxes on the Roth conversion and want more than $10k for the home purchase, you have plenty of room within the 28% bracket to do the rollover.

I tend to be a contrarian and I looked into this idea previously so here are my two cents.

1. I 'believe' there is a one time exception to 401k withdraw penalty if you are using the money as a down-payment on your primary residence.
You can only do it ONCE, it can't be more than 25% of the loan and you avoid the 10% early withdraw penalty.
I am NOT a tax adviser so check with yours to verify this information.

2. That being said you do need to pay 'normal' taxes on this withdraw - which sucks - BUT you're going to pay have to pay those taxes when you retire too so what's the difference - now or later - who cares. I personally am of the belief that the tax rate you'll pay NOW may be lower than what you would pay in the future. I believe the Govt is going to eventually raise taxes on these withdrawals in the future through so sort of 'extra' levy. I have no evidence or proof of this - just my opinion based on how the Government finds a way to get at stashes of money.

Based on the above, it MAY not be a bad option/investment for you to do this.
If property values go up considerably it's probably a good move. If they go down then it's a mistake.
So what do you think is going to happen? IMHO I think mostly like they will be going down because the US is in trouble.
Interest rates should stay low for some time to come (at least 1 more year - so I wouldn't 'RUSH' to try to lock in the current rates.)

So if i were you I would wait a bit longer. I would roll the money into a Scottrade, Merrill Edge or another similar account where you can buy/sell Stocks, ETF's, etc.
Take a couple investment classes and find some smart buys for the next year. Double your money and if you're ready to buy the house you can use these gains to offset the taxes.
I have $180k in similar accounts - and I MADE nearly 10% in the last few weeks. ($18,000) If I were more patient I would have made closer to 20%.
Now the stock markets have big risk - some would say we have a MAJOR correction (i.e. DROP) coming - and I actually agree.
The beauty of self directed account like this is that you can get OUT relatively quick. You buy on the dips and profit take on the gains.
Practice offline - meaning use a fake account - do your research (seekingalpha.com has good advice)
Write down what you would have bought and what you would have paid for it.
Watch the stocks you picked. Decide when you would have sold them - record your profit/loss, etc.
Do this for 3 months before you execute a single REAL trade. Determine what worked, what didn't, tune your strategy.
Start your buys small (<20% of your account), stick to your strategy and see if it works for you.
These lessons will serve you a lifetime regardless of what you decided to do here...

Good Luck. Its a tough financial environment right now.
Lots of very conservative folks around here - which is fine - but (I think) you're young so if the off chance your screw up bad you have plenty of time to make that up. Also, You should be putting away at least 10%. You might consider splitting that 10% between a 401k and a 401a. The 401a account is funded AFTER taxes so you take money out tax free in the future. (Again this will bunch up the panties of everyone here - but do your own research on this.) Consider where you think the country will be (in regard to taxes) when YOU reach retirement age - not necessary where it is right now.

Let the haters begin.

I have to disagree with the majority of the others. (Although many posts were made before Op's update.) Based on Op's updated savings and income info I don't see a problem with him buying a home. (Op please update your main post to add this extra info.).

Op you still never said what price range you're looking in, but I'm guessing you're shooting for 20% down. How about paying PMI now (rather then penalties and income tax ) and increase your equity and refinance in 12-24 months. - For this situation you would want a low closing cost loan for the time being. (Penfed or Navy Federal Credit Union?)

Sending $10,000 to an IRA , then withdrawing it seems like a good idea to avoid the 10% penalty on some of the money.

Op, with your income and low contribution rate to your 401k (but with kids), I'd say you continue building that 60k up to a down payment. If you realistically think you could manage the 401k loan, or the hit on a withdrawal/tax penalty, then you should be able to hold out another year to 18 months and save up your full down payment. In the meantime, you can lock in on exactly what you are looking for and where you want the house to be. Then in 12-18 months, you have the down payment and you should increase your contribution to your 401ks and IRAs.

I don't think an inactive 401k will allow a loan as recommended (and I would also recommend). OP, you should instead inquire with your current 401k admin about borrowing from that. That's where I think the discussion you specifically asked for - withdrawing from a 401k with limited tax consequnces - comes to an end. I think any other withdrawal will have unavoidable tax consequences and a bonus 10% penalty on top.

You don't think you can stay in your rented home 'long term'? Or rent in a good school district? I think your haste sounds completely misplaced. You really think at age 24 you know and can control where you will want to live for the next 10, 20, 30 years?

SlimTim said:   I don't think an inactive 401k will allow a loan as recommended (and I would also recommend). OP, you should instead inquire with your current 401k admin about borrowing from that. That's where I think the discussion you specifically asked for - withdrawing from a 401k with limited tax consequnces - comes to an end. I think any other withdrawal will have unavoidable tax consequences and a bonus 10% penalty on top.

You don't think you can stay in your rented home 'long term'? Or rent in a good school district? I think your haste sounds completely misplaced. You really think at age 24 you know and can control where you will want to live for the next 10, 20, 30 years?


Or the corollary to that, buying at 24 causes you to stay in a certain location which forces you to turn down better career opportunities elsewhere - because you have the house, etc. In that case, you are controlling where you want to live, but maybe sacrificing what you will be able to do/earn for a career.

ReformedCCCharger said:   

I know it seems like a random excuse, however, I want to be in home my wife and I can be in for a long time in a good school district for our two little ones.

Thank you for you reply.


In before wife rips his heart out and sticks him with the loan against his 401K. Hate to be a downer, but statistically your marriage will not last. You'd be smart not to torpedo your future for a woman.

You can take a loan from the 401k. The interest is around 4 or 5% depending on the terms. But you pay the interest to yourself (yourself = your 401k account).
In stead of taking the money outright (with taxes and then penalty), you pay it back... you get less paycheck though.
Also, If I were you, I would invest a little more (at least 12%) into 401K as it would bring your fed tax percentage down.

Be very careful with a 401k loan. If you switch employers, you'll need to pay it off or pay taxes plus the 10% penalty.

If I were you, I would wait and save up for a larger down payment.

However, if you decide to buy, can you do all of us one BIG, HUGE favor? Please, please, if things go bad, don't go on TV and blame society for your problems (and ask for a bailout). Instead, please take responsibility. That is all.

Nicely put. I was in a similar sitution after my kid was born. My wife stayed at home and it was a struggle to get by on one income. My savings dropped quite a lot -- no 401k for her, not maximising my 401k and not being able to have a sufficient emergency fund since everything was on 1 paycheck. We got lucky that jobs were still around . Cant say that anymore. Good Luck
sgogo said:   ReformedCCCharger said:   Hi Public,

Thanks for the info. In terms of income I make 90k salary per year and my wife makes 76k per year. We both invest in our 401k's to the company match of 4%.

We are currently renting a home in So. California for $2,400 per month which we are very comfortable with and have been paying that for 2.5 years. We have roughly $60,000 currently saved and simply need to get to 80k-100k for a down payment.

In terms of tax bracket, I am not sure how close we are to the next bracket. Taxes are not my strong suit.


Your numbers are very good for your age. The fact that you saved 60k in a couple of years is impressive.

However, keep in mind that when you buy this new house, with 100k down, you will be out of money. No savings. No 401k to borrow from. You will have the mortgage and the 401k loan to pay back.

I am not saying you shouldn't do it... but you have two young kids. A medical problem, a loss of one of your jobs, etc. could put you in a situation where you need to sell this house, and it might take some time to do in this market.

And, who knows, the market might get even worse ... I don't think so, but you should always plan for the worst.

SteveG

galabar said:   Be very careful with a 401k loan. If you switch employers, you'll need to pay it off or pay taxes plus the 10% penalty.

If I were you, I would wait and save up for a larger down payment.

However, if you decide to buy, can you do all of us one BIG, HUGE favor? Please, please, if things go bad, don't go on TV and blame society for your problems (and ask for a bailout). Instead, please take responsibility. That is all.


If OP withdraws it out now, he has to pay the penalty and taxes anyway. With loan however, he pays penalty and taxes on the remaining balance - only if he loses his job.

I guess OP already mentioned this was from previous employer. I hope you consolidated it to your current 401K.

ReformedCCCharger said:   Hi Public,

Thanks for the info. In terms of income I make 90k salary per year and my wife makes 76k per year...We have roughly $60,000 currently saved and simply need to get to 80k-100k for a down payment.
You have $166k income and are $20-40k short of your goal? Easy - just wait until next year to start shopping. By then, you'll have the money in the bank.

Patience, grasshopper.

OP - Go for it. Sure, you take a hit financially for now, but in So Cal, living in a good school district has intangible value in itself. As for limiting tax liability, not much options there but to rollover and borrow. The mortgage deduction will help somewhat during tax time too.

kriskos4 said:   ReformedCCCharger said:   

I know it seems like a random excuse, however, I want to be in home my wife and I can be in for a long time in a good school district for our two little ones.

Thank you for you reply.


In before wife rips his heart out and sticks him with the loan against his 401K. Hate to be a downer, but statistically your marriage will not last. You'd be smart not to torpedo your future for a woman.

Why not disclose that at least some of your bias ("wife rips his heart out", "smart not to torpedo your future for a woman") comes from your own unhappy experience? I hope that eventually you can let go of this and move on. Believe it or not, your experience is not the norm.

ETA: I also hope that your financial situation that resulted from all this will improve soon.

Skipping 3 Messages...
Do it. I live in CA and had to do the same thing. If you actually do your homework, you'll find out that you'll have 2 options: 1. Take a loan out against your 401k and its a repayment of the balance plus 2% over X amount of time......or 2. Take a hard withdrawal and pay 10% tax penalty.

Unfortunately, i had to take the penalty withdrawal but I think I more than made up for when I up'd my contribution level and opened an additional Roth IRA account (I felt guilty).



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