Can I Use 401(k) Funds to Build a House?

Tapping your 401(k) early to build a home might not be the best idea.

Tapping your 401(k) early to build a home might not be the best idea.

If you're 59 1/2, you've reached that magical age when you can take money out of your 401(k) plan and use it for anything you want, without penalty. However, any earlier and you pay 10 percent additional tax unless your distribution meets a specific exception, which building a home does not.

Hardship Distributions

Typically, you can take a distribution from your 401(k) plan only when you've reached age 59 1/2 or separated from your employer. However, if you have a qualifying financial hardship, you may be able to access the money sooner. Qualifying hardships must be an immediate and heavy financial need. The Internal Revenue Service includes costs related to buying a primary residence as a potential hardship distribution. However, the IRS gives discretion to each plan to determine what the plan will allow as such a distribution.

Limits

If your plan will allow you to take a hardship distribution to build your house, you can't withdraw more than the home's cost plus taxes and penalties. In addition, you can only take a hardship distribution from your elective deferrals. Some plans may also allow employer contributions to be included in the amount eligible for a hardship distribution. However, you can't touch the earnings in your 401(k) plan. For example, if the $35,000 you've contributed to your plan has blossomed to $50,000, your hardship withdrawal still can't exceed $35,000.

Penalties

Like all other 401(k) withdrawals, hardship withdrawals are subject to income taxes. In addition, they are subject to 10 percent additional tax. For example, if you are in the 25 percent tax bracket, you would essentially be paying a 35 percent tax rate on the distribution. In addition, you can't make elective deferrals to your 401(k) plan for six months after you take a hardship distribution, which could prevent you from taking full advantage of an employer's matching contributions.

Alternatives

Before you take a hardship distribution, you should exhaust your other financing options. If your plan allows, consider a 401(k) loan. You can borrow up to $50,000 or half of your account balance, whichever is smaller. A loan allows you to avoid the 10 percent additional tax as long as you repay it as agreed and you don't hamstring your 401(k) plan. Alternatively, if you have an IRA and are a first-time home buyer, you can use up to $10,000 to build your first home and not pay the 10 percent additional tax on the early distribution.

 

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