Raiding Your 401(k) to Refinance

Your employer may allow you to borrow from your 401(k) when you refinance your home.
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The idea of siphoning funds out of your retirement nest egg might sound tempting if you need cash to cover some of the costs of refinancing. But, while refinancing to a lower interest loan may reduce your monthly expenses, you must take into account the costs involved before you plunder your 401(k). Federal tax laws are designed to discourage young adults from accessing these funds prior to retirement. Your employer also has the option of imposing withdrawal restrictions, and you may find that your retirement funds are strictly out of bounds.


You can only withdraw money from your current employer's 401(k) plan if you experience an event that meets the Internal Revenue Service's definition of a financial hardship. The IRS defines a "hardship" as buying your first home, repairing a home or paying money to save a home from foreclosure, along with a few other things. But the IRS hardship rules say nothing about refinancing. So you might regard paying your current mortgage payment as a hardship, but the IRS does not look at in the same way. Furthermore, the IRS allows your employer to impose even tighter restrictions on the definition of hardship withdrawals, and many firms simply do not allow withdrawals of any kind.


Don't despair, though. Even if you can't cash in your 401(k), your employer may allow you to take out a 401(k) loan. Under IRS rules, you can borrow up to $50,000 or up to half the value of your plan, whichever is less, in the form of a retirement plan loan. You will have to pay interest on the loan, but both the principal and the interest are deposited back into your 401(k) account and you have up to five years to pay the loan back. However, as with withdrawals, the IRS allows your company to make the final decision on whether it will allow loans from its 401(k) plan, and some companies exclude loan provisions from their plans. Even if a loan is allowed, be wary: if you leave your job before the loan term ends, you must immediately repay the balance owed or accept the money as a taxable distribution, which means you will owe the IRS income taxes plus a 10 percent penalty on the full amount. Ouch.

Former Employers

If you cannot access any money inside your current employer's plan, you can at least withdraw money from 401(k)s held with former employers. Keep in mind, though, that these plans were funded with pre-tax contributions, which means you will have to pay state and federal income tax on any money you withdraw, plus the 10 percent penalty (assuming you are not 59 1/2 yet.) Depending on your income tax bracket, you may lose almost half of the money you withdraw to the IRS and state tax collectors before you even get a chance to pour it into your house. Again -- ouch.


Accessing your 401(k) funds can prove costly and difficult, but you may find that you do not even have as much money in the account as you imagined. Under federal tax rules, employers can use five-year vesting schedules for these plans. This means that company matching contributions become your property or vested at a rate of 20 percent per year. In other words, your own contributions belong to you from the time you deposit them, but if you have not worked in your job for long most of the money your employer contributed may still technically belong to the firm. If you can make a withdrawal or take out a loan, you can only withdraw your vested funds. So the amount you actually have to draw from may not equal the full balance of the plan.

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