A large down payment is what makes a home purchase possible for many people. Lenders like to see at least 20% down on a home. This helps make the loan less risky for the lender. The more money you have invested in the property, the more likely you are to make your payments. What happens if you cannot come up with a down payment, though? Maybe you lost your job and are trying to make ends meet or you had to use your savings on a medical emergency. There is one option; it is called the 401K hardship withdrawal.
Qualifying for the 401K Hardship Withdrawal
Under normal circumstances, you cannot withdraw from your 401K until you are 59 ½. The only exception to the rule is if you take out a 401K loan. The 401K withdrawal, however, is not a loan. It is a permanent withdrawal of the money. In order to qualify, you must prove some type of hardship. A few examples include losing your job and still trying to recover or being unable to work due to a medical condition.
Each plan administrator has different requirements regarding the proof of a hardship. Talk to your employer’s HR department about what you need to provide. Basically, you will have to prove you do not have any other money and explain why. Your reasons must be able to be proven so the HR department can approve your request to withdraw the money early.
Uses for the 401K Money
The IRS only allows you to use your money from the 401K for specific reasons. One of which is to purchase a principal residence. However, you have to prove that you do not have any other funds you can use for the down payment. For example, you cannot have a savings account with $10,000 in it just sitting there and expect to take money out of your 401K for the down payment.
The money you withdraw from your 401K must be used specifically for the down payment. You may only withdraw the amount you need for the down payment – you cannot just keep the leftover funds. For example, if you must put $10,000 down on a home to purchase it, you may be able to withdraw $10,000 from your 401K. The only exception is if you need the money to pay the penalty and taxes on the money, which we will discuss below.
The Implications of Taking Money Out of your 401K
Generally, you are supposed to use your 401K for retirement. In the ideal situation, you would not withdraw the money until you were at least 59 ½ years old. In the case of a hardship, though, you can take the money out for a penalty. Right now you must pay 10% of the amount you withdraw in a penalty. You must also claim the money on your income taxes and pay the appropriate taxes on the money.
Determining the Amount
The amount you may withdraw is based on several factors:
- The amount you need for the down payment, which you can prove by the loan documents provided by the lender
- The amount you contributed to your 401K outside of any matching contributions your employer made
Keep in mind, you never repay the 401K. This is not a loan; it is a direct deduction of your 401K amount. This means you lose out on the interest and any other earnings you may have gathered by leaving the money in the account.
Should you Withdraw from Your 401K
As the name suggests, you should only withdraw from your 401K in a hardship situation. Take a close look at all of your other options to determine if you can get the money elsewhere. Personal loans, or even gifts from family members are just two of the options you may have available to you. As you take money out of your retirement account, you just make things more difficult for you when you retire. Depending on your current age, you may still have to pay the mortgage you take out on your home. If you do not have substantial retirement funds, you could find yourself in a financial bind in your senior years.
The 401K hardship withdrawal is there if you need it, but make sure to determine if it is the right choice for you. Remember that you will owe a 10% penalty as well as the income taxes. This could make tax time rather expensive for you. Consider all of your options and use the 401K withdrawal as the last resort whenever possible.
