Can I Use My 401(k) Early to Save My House if I Am in Danger of Foreclosure?

by Cynthia Gomez

If your spouse lost her job, or you or a loved one find yourselves drowning in medical expenses, you may find yourself in danger of losing your home. While digging into retirement savings should never be a first choice, you may be able to use your 401k account to save your home from foreclosure.

Hardship Withdrawal

Generally, any withdrawals from a 401k plan made before the participant reaches age 59 1/2 are taxed as regular income plus penalized with an additional 10 percent tax. While not required to do so, some plans allow for hardship withdrawals. These withdrawals are only allowed under very specific circumstances, one of which is making a withdrawal to prevent the loss of, or eviction from, a principal residence.

Requirements

For the purposes of the IRS, the hardship must "be on account of an immediate and heavy financial need." The employee must also not have other resources that could be used to meet that need. This could include resources of a spouse or minor children. For example, an employee who has a vacation home in the name of his spouse could be considered to have other resources to satisfy his creditors and avoid foreclosure on his principal residence. For that reason, the employee may have to provide proof of both the need and the lack of other resources.

Considerations

The amount of the withdrawal can't exceed the need, or in this case, the amount necessary to avoid the foreclosure. Most plans also restrict the amount of the withdrawal to the employee's own plan contributions less any previous withdrawals he might have made, meaning earnings and employer matching contributions are usually not included. Plans may also restrict employees who have taken hardship withdrawals from making new plan contributions or receiving matching funds for up to six months.

Alternative

Hardship withdrawals cannot be returned to the plan. In addition, while not subject to penalty, they are treated as regular income for tax purposes. A better alternative might be to take a loan from your 401k. While employers do not have to allow loans, when they do, the requirements are usually less strict. The IRS specifies that you can only borrow up to 50 percent of the vested balance of your 401k, with a maximum borrowing cap of $50,000. While you must pay your loan back over a specified period, loans are not subject to taxes or penalties, and the interest you pay on the loan goes back into your account, thus not setting you back the way a hardship withdrawal would. However, if you happen to get laid off or fired before the loan has been paid back, the full balance will become due immediately.

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