A:

As you may already know, you must meet certain requirements, outlined in the 401(k) plan document, to be considered eligible to receive a distribution from the plan. Your employer or plan administrator will provide you with a list of the requirements.

Amounts withdrawn from your 401(k) plan and used towards the purchase of your home will be subject to income tax and a 10% early-distribution penalty. This applies even though the distribution will be used towards the purchase of your first home, because the first-time homebuyer exception does not apply to distributions from qualified plans such as 401(k) plans. Furthermore, if the amount you receive is rollover eligible, your employer is required by law to withhold 20% for federal tax, unless the amount is rolled directly to an IRA or other eligible retirement plan. Your employer must tell you whether the amount is rollover eligible.

Assuming you are eligible to receive the distribution and the amount is rollover eligible, you may instruct the 401(k) plan to process your distribution as a direct rollover to an IRA. This will ensure that the 20% federal tax withholding is not applied to the amount. Additionally, you can then withdraw the amount from your IRA for use towards the purchase of your first home, thereby avoiding the 10% early-distribution penalty. Remember, the maximum amount that may be distributed from the IRA on a penalty-free basis for the purpose of buying a first home is $10,000. This is a lifetime limit.

If you are under age 59-½ when the distribution occurs, your IRA custodian may report the distribution as being eligible for an exception to the 10% penalty. This is indicated with a code '2' in box 7 of Form 1099-R. If the custodian does not make this indication, you may file IRS Form 5329 to claim the exception.

This question was answered by Denise Appleby

(Contact Denise)

RELATED FAQS
  1. I have just been laid off. Can I use my 401(k) for living expenses now and report ...

    Any amounts withdrawn from your 401(k) plan must be treated as ordinary income for the year the amount is distributed from ... Read Answer >>
Related Articles
  1. Retirement

    9 Penalty-Free IRA Withdrawals

    If you need to take early distributions, find out which exemptions allow you to avoid expensive consequences.
  2. Retirement

    Tips For Moving Retirement Plan Assets

    Moving assets is common when changing jobs or retiring, but you have to do this carefully to avoid penalties.
  3. Investing

    Understanding the Benefits of Rollover IRAs

    Need help deciding what to do with your 401(k) plan from a former employer? Here are your options.
  4. Financial Advisor

    Best Ways to Roll Over Your 401(k)

    When you leave a job, you have some decisions to make about what to do with your 401(k). Here are some choices.
  5. Financial Advisor

    Tough Times: Should You Dip Into Your Qualified Plan?

    401(k)s, pensions and profit-sharing plans can be a source of cash, but there are consequences to this option.
  6. Retirement

    What Happens to a 401(k) After You Leave Your Job?

    Find out what happens to your 401(k) after you leave your job. Learn about your five primary options, including cashing out and rolling over to a new plan.
  7. Retirement

    Guide To 401(k) And IRA Rollovers

    Follow the steps detailed below when you need to roll over your 401(k) or IRA account to be sure you preserve tax benefits and avoid penalties.
  8. Retirement

    Avoiding IRS Penalties On Your IRA Assets

    The best way to avoid additional charges and taxes is to know which transactions have expensive consequences.
  9. Retirement

    What to Do With Your 401(k) if You Change Jobs

    There are several options for your old 401(k) if you start working for a new employer.
RELATED TERMS
  1. Eligible Rollover Distribution

    A distribution from an IRA, qualified plan, 403(b) plan or 457 ...
  2. Non-Qualified Distribution

    1) A distribution from a Roth IRA that occurs before the Roth ...
  3. First-Time Home Buyer

    An individual who is purchasing a principal residence for the ...
  4. IRA Rollover

    A transfer of funds from a retirement account into a Traditional ...
  5. 401(k) Plan

    A qualified plan established by employers to which eligible employees ...
  6. IRS Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs)

    IRS Publication-B outlines the rules for making distributions ...
Hot Definitions
  1. Risk-Return Tradeoff

    The principle that potential return rises with an increase in risk. Low levels of uncertainty (low-risk) are associated with ...
  2. Racketeering

    A fraudulent service built to serve a problem that wouldn't otherwise exist without the influence of the enterprise offering ...
  3. Aggregate Demand

    The total amount of goods and services demanded in the economy at a given overall price level and in a given time period.
  4. Fixed Cost

    A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses ...
  5. Blue Chip

    A blue chip is a nationally recognized, well-established, and financially sound company.
  6. Payback Period

    The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
Trading Center