Your 401(k) questions answered

By David Pitt ASSOCIATED PRESS | Thursday, September 18, 2008

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Banks often want as much as 20 percent down when you buy a home, a big payment that's often hard to come by. So, it can be very tempting to tap into your retirement account. That decision will cost you in the long run, so it's something that should be thought out thoroughly before moving forward.

Borrowing or taking a withdrawal from your 401(k) is the topic of this week's question.

Q: Can I borrow from my 401(k) account to help buy a home without penalty?

Both loans and hardship withdrawals can be used for a home purchase if permitted under your plan. However, not every plan allows such options, so you'll need to check with your administrator.

First, you may be able to borrow up to 50 percent of your account balance, up to $50,000 and you'll repay the loan through a paycheck deduction. Most loans must be repaid within 5 years, but loans for buying a home may be spread over a longer period. You won't be taxed on the loan amount, but you must pay interest on the loan usually a couple of points above prime. Of course, you'll be paying it to yourself. The drawback is that the interest rate is likely to be less than the returns the funds would have otherwise earned.

If you leave your employer, the entire balance of your loan will be due likely within a couple of months. If you can't repay it, the loan will be treated as if you withdrew the money early from your account, which means you'll pay federal income tax plus a 10 percent federal penalty tax if you are under age 59.

The Investment Company Institute, a trade group of U.S. investment companies, says 58 percent of 401(k) plans offer loans, but most workers don't exercise that option. Some plan administrators have reported increases in the number of borrowers in the past few years, and it appears slightly more than 20 percent of those eligible to borrow have outstanding loans. Average balances were typically around $7,000.

A second option, the hardship withdrawal doesn't have to be paid back, but it is subject to current-year federal income taxes and, if you're under 59, the 10 percent early withdrawal federal penalty tax.

To be eligible, you must have exhausted other funds or ways to meet your hardship, including a plan loan, and you can't contribute to the plan for six months following the withdrawal.

The following items are considered by the Internal Revenue Service as acceptable reasons for a hardship withdrawal: Unreimbursed medical expenses for you, your spouse, or dependents Purchase of an employee's principal residence Payment of college tuition and related educational costs for you, your spouse, dependents, or children who are no longer dependents Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence Funeral expenses Repair of a primary residence

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