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Amounts withdrawn from your 401(k) plan and used towards the purchase of your home will be subject to income tax and a 10% early-distribution penalty.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 <?xml:namespace prefix = st1 /?>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. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  3. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  4. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
  5. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>
  6. Is my IRA protected in a bankruptcy?

    All types of individual retirement accounts, or IRAs, recognized under the federal tax code enjoy substantial protection ... Read Full Answer >>
Related Articles
  1. Professionals

    How to Protect Elderly Clients from Predators

    Advisors dealing with older clients face a specific set of difficulties. Here's how to help protect them.
  2. Professionals

    Social Security 'Start, Stop, Start' Explained

    The start, stop, start Social Security strategy is complicated. Here's what retirees considering it need to consider.
  3. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  4. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  5. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  6. Professionals

    Don't Let Your Portfolio Be Trump'd by Illiquidity

    A look at Donald Trump's statement of finances and the biggest lesson every investor can learn.
  7. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  8. Retirement

    Maxing Out Your 401(k) Is Profitable: Here's Why

    It's shocking, but most American workers (73%) have no 401(k) retirement funds. Start saving now to anchor your retirement.
  9. Professionals

    Top Questions to Ask When Choosing a Robo-Advisor

    Think a robo-advisor might be the right choice for you? Be sure to ask these questions first.
  10. Professionals

    Top Retirement Hack? Start with a Lifestyle Change

    Instead of going through the usual retirement planning steps, some people are focusing on fostering a lower cost lifestyle from the start.
RELATED TERMS
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. Fair Housing Act

    This law (Title VIII of the Civil Rights Act of 1968) forbids ...
  3. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  4. Construction Loan

    A short-term loan used to finance the building of a home or another ...
  5. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  6. Self Invested Personal Pension (SIPP)

    A tax-efficient retirement savings account available in Great ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!