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What You Should Know About Using 401(k) Money to Buy Your First Home

Posted on in Taxation Law

: San Jose, CA 401(k) tax attorney

A 401(k) is a retirement savings plan available for workers whose employers offer or have agreed to sponsor the plan. The plan allows employees to save and invest part of their earned wages or salary before taxes are deducted. Payment of taxes on these retirement savings and contributions, however, is only deferred to when the money is withdrawn from the 401(k) account. It is important to understand the restrictions and taxes that may apply if you are considering using these savings to purchase a home.

Restrictions on 401(k)s

Saving for retirement via a 401(k) plan can be very beneficial. However, it is also important to note that a 401(k) plan has many restrictions set by the Internal Revenue Service (IRS) with which you must comply.

For example, you cannot touch your employer’s contributions immediately. Before you do so, “vesting” must take place. Vesting is the time you must work for your employer before being allowed to access your employer’s portion of contributions to your 401(k). Your own contributions vest immediately.

Even after your money is vested, there are other rules and restrictions as to when you can withdraw the money. Early withdrawal of funds before reaching the retirement age of 59 ½ is subject to a 10% penalty.

Individual Retirement Accounts (IRAs)

While a 401(k) plan is great for retirement saving, this plan may not build up enough savings to allow you to retire comfortably without any financial worries. For this reason, financial institutions have other types of accounts you can open to save for retirement. These individual savings accounts are referred to as IRAs, and they allow you to grow your money tax-free or on a tax-deferred basis. You are also allowed to withdraw money from your IRA account and use it without penalty for specific purposes, such as a down payment for buying your first home.

Using 401(k) Money as a Down Payment

You may have heard from a neighbor, friend, or workmate that you can use money from your 401(k) to use as a down payment to buy a home. This information is technically accurate to the extent you can always withdraw money from your 401(k), so long as the money is vested. However, the issue is not whether you can withdraw vested money; rather, the problem is the consequences of early withdrawal.

Penalties and Consequences of Early Withdrawal From a 401(k)

Although withdrawal from an IRA is allowed to use the money for specific purposes such as a down payment for a first-time home buyer, the U.S. Tax Court has recently split hairs and ruled that this option is not available for those who have their money in a 401(k) account. This means if you withdraw money from your 401(k) plan to use as a down payment for a home you are purchasing, you will be subject to the 10% penalty, in addition to the taxes that will apply to this withdrawal.

Get Proper Advice from a San Francisco Bay Area Tax Lawyer

At John D. Teter Law Offices, we are experienced in handling complex tax matters, and we can help you understand the nuances of tax laws in all instances where large amounts of money may be changing hands, such as withdrawals from a 401(k). We can help you determine the potential benefits or drawbacks of such withdrawals or exchanges. If you are thinking about withdrawing money from your 401(k), or if you are dealing with a situation involving large amounts of money, contact our San Jose tax lawyer for advice on the best way to go about doing this without exposing yourself to unnecessary consequences. Call our office today at 408-866-1810.

Sources:

https://uscode.house.gov/view.xhtml?req=qualified+pension%2C+profit+sharing+%2C+and+stock&f=treesort&fq=true&num=13&hl=true&edition=prelim&granuleId=USC-prelim-title26-section401

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