Can my fiancé use his 401(a) for a down payment on a house instead of cashing it out?

My fiancé is leaving a city job for a government job that offers a pension. At his previous job he had a 401(a). Instead of cashing it out and receiving all the tax penalties, can he roll it over to use it as a down payment on a house instead and not get those penalties? If yes, who and how would we go about this?

Pensions, Real Estate
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August 2016
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Generally, it is possible to rollover a 401(a) to an IRA after early termination of employment. Your fiancé should speak with his HR department about requesting a “direct rollover” to an IRA he can open at any of a number of custodians, e.g. – Schwab, Fidelity, etc. A direct rollover is when the plan trustee distributes an account directly to the trustee, the custodian, of the new account. A direct rollover allows you to avoid withholding 20% of the distribution for Federal income taxes which can occur when attempting an “indirect rollover.”

Once the funds have been transferred from the 401(a) to the IRA, your fiancé will be permitted to withdraw up to $10,000 or the full balance of the account, whichever is greater, to help pay for a first-time home purchase. While this withdrawal will not face the 10% excise penalty levied by the IRS on early distributions, before age 59 ½, the full amount will be subject to ordinary income taxes.

For example if your fiancé is in the 25% Federal Income Tax bracket, a $10,000 withdrawal would generate a $2,500 income tax bill. Additionally, depending on your State of residence, he may face state income tax consequences from the distribution as well. The funds he withdraws from his IRA must be used for “qualified acquisition costs” within 120 days of receiving the distribution. Proof that he used the funds to buy, build or rebuild a home within the time frame may be needed to satisfy questions raised by the IRS about the distribution when he files his 2016 taxes.

I would caution you to think about this distribution critically. Reducing the value of a retirement account, even with a new pension, can have severe long-term consequences. You will be losing the power of tax-deferred compounding, which can be extremely beneficial, for your retirement. It may make more sense, and cents, to delay your home purchase until you have enough funds outside of retirement accounts to make a down payment on your first home.  

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