Liquidating Retirement Funds for a Down Payment!

by Mario Acosta on March 31, 2015

in Buyers, First-Time Home Buyers

Mortgage planning

Whether it’s first time, boomerangs or move up buyers, the down payment is often the biggest obstacle to homeownership. Credit scores can be boosted, promotions and job changes can increase income and debt can be paid off /down …all issues best left to your loan officer. In addition to down payment, typical closing costs (even with a “zero point” loan) will add another 2% to the transaction’s cost. All of which begs the question “how to get the down” AND “how much is needed”? Many buyers have retirement accounts but are hesitant to access the funds because of a lack of understanding on how their specific account and processing work. And a lack of understanding is not something they will readily disclose; making your job more difficult.

Here are the basics: 401(k) Loan:

 For the purposes of qualifying for a mortgage, borrowers must qualify with the (re) payment of the 401k loan in conjunction with qualifying for mortgage. Generally speaking an employee may only have one 401k loan at any given time, although there can be exceptions and a current loan can be rolled into a new loan with a higher balance for the purposes of a home loan.

A buyer may borrow up to 50% or $50,000 of their 401(k) funds for a down payment, whichever is less. Borrower/buyers will be required to provide the lender with the terms of repayment (typically with an employer handbook). Borrowing rates on 401(k) loans are set by the institution that administers the 401(k) which is chosen by the employer. Typically its 1-2 percentage points above the current “prime rate”and typically amortized over 10 years. This is far more advisable than paying taxes and penalties for early IRA withdrawal.The portion removed from the borrowers account is placed in an interest-bearing account. So borrowers lose some, but not all of their ability to stay invested. If a borrower leaves the employer administering the 401(k), they have 90 days to repay the remaining loan balance or if not, will receive a “1099” for the outstanding balance, and pay income tax on the money.

And the possible penalties for “under withholding”. Borrowers younger than 59 1/ 2 years are subject to 10% penalty for “early withdrawal” if escrow doesn’t close within 60 days. Borrowers liquidating more than $10,000, 20% of the overage will be withheld for taxes (but taxes will eventually be about 35%). On top of this, federal and state penalties are about 12.5% on anything above $10,000. CRITICAL: If you have a 401k from a former employer, it must be rolled over into the new employer’s 401k plan to be eligible for a new loan.

Liquidating IRAs

Borrowers are allowed to take up to $10,000 penalty free for buying a first time home.

Married couples are allowed up to $10,000 from each account (for a total of $20,000).  If borrowers liquidate more than $10,000, 20% of the overage will be withheld for taxes (the taxes will eventually be about 35%). The definition of first time home buyer is a person who hasn’t owned a PRINCIPAL RESIDENCE over the past two years. Owning a rental property or a vacation home doesn’t disqualify you. NOTE: The home transaction must COE within 120 days of the withdrawal.


 Roth IRA contributions are made with after-tax dollars so you can withdraw your contributions at any time for down payment (or any other reason) with no tax liability.

But if a borrower withdraws any CAPITAL GAINS that the ROTH ACCUMULATES “beyond” cash contributions, there are more rules.

After the initial $10,000, any withdrawals from capital gains are taxed as income and have a 10% penalty unless two things are true:

 (1) The withdrawal occurs after five full “tax years.” A “tax year” begins January 1 of the contribution year, even if the contribution is made on December 31.

(2) A first-time homebuyer is defined as someone who hasn’t owned a principal residence for three years.

A family member can help a spouse, child, or grandchild who is a first-time homebuyer, and can make from Roth IRA withdrawal of up to $10,000 capital gains free, penalty-free.

SEP Retirement Plan ( Simplified Employee Pension)

 For the sake of brevity click here for the IRS specifics of SEP plans. SEP plans are basically an IRA with higher contribution limits. Sole proprietors, partnerships, and corporations, including S corporations, can set up SEPs. SEPS are eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of starting the plan. These monies can be rolled over tax free into traditional IRA for the sake of a first time homeowner’s withdrawal.

To find out more, contact Mario Acosta 818.925.4470.

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Post by Mario Acosta

Mario has written 59 articles.

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