Although most people refrain from touching their retirement funds until their retirement time, certain critical financial situations may warrant an early withdrawal.
However, the process of withdrawing is a tedious one, involving lots of rules and regulations from the Internal Revenue Service (IRS). Besides, you are required to pay several penalties and taxes upon your withdrawn amount.
The first rule is that you must be able to prove to the IRS officials that you are going through a financial hardship.
Secondly, you should be able to prove that it is your last resort of fulfilling your financial need. You should not have any other funds available, that could suffice your financial needs.
Thirdly, you are not allowed to withdraw anything your need. Meaning, if you are required to make a down payment of $10,000, and you cannot arrange for own contribution, then you are allowed to withdraw only $10,000 from your 401k account (provided you have enough balance in it).
The fourth rule is that you should have executed all other options of taxable loans, so that 401k withdrawal is your last option of raising funds for home purchase. After your withdrawal, you cannot contribute to your account for a span of 6 months.
Buying a House Using a 401k Withdrawal
The 401k regulations explicitly state that the withdrawal can be made only for a purchase of a first home. You cannot use this money to make a down payment for your second home. The money withdrawn from this account is taxable.
One important thing to remember, while applying for an early withdrawal is that, although the law permits an early withdrawal, it is not mandatory for the employers to offer such a provision in their plan.
Hence, inquire with your human resources department, to know the provision in your individual plan. Also, beware of the penalties you will be subjected to, upon the withdrawn amount. A study of IRS regulations, may give you a clear idea regarding the taxes and penalties.
At times, you may notice that after paying taxes and penalties, you are only left with considerably less amount than your exact need. Hence, you might anyway have to arrange for funds to cover up the difference.
Withdrawing from your 401k funds is definitely not the wisest of all options. For one thing, you lose out on a large sum from your retirement funds, which can make your life after retirement less than secure.
You unnecessarily have to bear the burden of taxes and penalties. Besides, you lose out on interest that would have incurred on the withdrawn amount. Hence, you should choose this option only when you are left with no other choice.
Borrowing, in this case, may seem to be a good alternative, as it is free of tax and penalties. Besides, the interest accrued from your loan goes back to your account. The repayment span may be anywhere between 5 to 30 years.