My 401k provider offers the ability to take a hardship distribution with instant approval(no documentation required) for the purpose of purchasing a primary residence. If I pay taxes on the full amount I draw as required by the IRS what are the consequences if I dont use that amount to purchase a property? Due to a large reduction in pay I am looking at a way of avoiding bankruptcy but obviously dont want to land myself in too much hot water with the IRS. Are there additional penalties and fees if were to get audited or is this something that could carry stiffer penalties? Thanks in advance for the information.
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401k hardship distribution
- Thread starter MTBman
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LdiJ
Senior Member
The maximum amount of money from a retirement account distribution that can be excluded from penalty (not tax just penalty) for the purchase of a primary residence is 10k. If you take out more than that or spend less than the 10k on the downpayment for the home, then the rest is not excludable from penalty.
However, will this distribution be a loan from your 401k or a full distribution? That makes a difference as a loan would not impact your taxes at all...or at least would not impact them until you came to a point in time where you could no longer repay the loan.
cbg
I'm a Northern Girl
Um, yeah, you might say that.
To start with, if your employer is allowing hardship withdrawals from the 401k without documentation, they are violating the law right there. And they WILL be caught -every 401k plan is audited regularly.
The IRS does not play around with this. They are VERY serious about the restrictions on hardship withdrawals. Your W-2 will show that you've taken a hardship withdrawal. The IRS is going to want to see the other associated costs with making the purchase. They do not state on their website what the penalties would be if you are caught taking a hardship withdrawal and then using the money for something else, but I think you can safely assume that they will be dire.
It is not outside the realm of possibility that your employer's right to offer a 401k plan to its employees could be revoked. Particularly if your employer is not requiring documentation before releasing funds.
To start with, if your employer is allowing hardship withdrawals from the 401k without documentation, they are violating the law right there. And they WILL be caught -every 401k plan is audited regularly.
The IRS does not play around with this. They are VERY serious about the restrictions on hardship withdrawals. Your W-2 will show that you've taken a hardship withdrawal. The IRS is going to want to see the other associated costs with making the purchase. They do not state on their website what the penalties would be if you are caught taking a hardship withdrawal and then using the money for something else, but I think you can safely assume that they will be dire.
It is not outside the realm of possibility that your employer's right to offer a 401k plan to its employees could be revoked. Particularly if your employer is not requiring documentation before releasing funds.
Not legal advice, but...
If you're facing bankruptcy, tapping your 401k to delay the inevitable is probably a bad idea. If you can pay off ALL your debts (and avoid getting any new debt) it might be a way to wipe the slate clean. Can you afford to live your lifestyle on the money you make today? Stealing from the future to pay for yesterday's purchases is a bad plan.
Money in a qualified retirement plan is usually safe from creditors. Move it out of the retirement plan, and it's not.
If you're facing bankruptcy, tapping your 401k to delay the inevitable is probably a bad idea. If you can pay off ALL your debts (and avoid getting any new debt) it might be a way to wipe the slate clean. Can you afford to live your lifestyle on the money you make today? Stealing from the future to pay for yesterday's purchases is a bad plan.
Money in a qualified retirement plan is usually safe from creditors. Move it out of the retirement plan, and it's not.
I hate to be the person to say this but you're all wrong.
There is no exception to penalty for first time homebuyers on 401(k) distributions. That exception only exists for IRA's.
OP, you are going to get a 1099-R for your harship distribution. What you use the money is wholly irrelevant to your tax impact and quite frankly the IRS doesn't really care so long as you report the income as an early distribution.
CBG, 401(k) distributions are not reported on W-2s.
There is no exception to penalty for first time homebuyers on 401(k) distributions. That exception only exists for IRA's.
OP, you are going to get a 1099-R for your harship distribution. What you use the money is wholly irrelevant to your tax impact and quite frankly the IRS doesn't really care so long as you report the income as an early distribution.
CBG, 401(k) distributions are not reported on W-2s.
cbg
I'm a Northern Girl
You're right; mea culpa. I meant to say 1099 and got distracted.
But I do not agree that he can claim to be taking a hardship distribution for a home purchase and then use it for a not-permissible use, with no consequences. The IRS doesn't set up rules and then just look the other way when they are violated.
But I do not agree that he can claim to be taking a hardship distribution for a home purchase and then use it for a not-permissible use, with no consequences. The IRS doesn't set up rules and then just look the other way when they are violated.
Ok perhaps certan things are being confused here. The taxability and penalty of the distribution has nothing to do with the usage of the money. There is no homebuyer exception to 401(k) distributions/
That said, the IRS is only in charge of form compliance with retirement plans. When it comes to operational components such as adhering to plan requirements, that falls under DOL jurisdiction.
That said, the IRS is only in charge of form compliance with retirement plans. When it comes to operational components such as adhering to plan requirements, that falls under DOL jurisdiction.
LdiJ
Senior Member
cbg
I'm a Northern Girl
The following are the six reasons permissible for hardship withdrawals from a 401k plan:
1.) Un-reimbursed medical expenses for you, your spouse, or dependents.
2.) Purchase of an employee's principal residence.
3.) Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
4.) Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
5.) For funeral expenses.
6.) Certain expenses for the repair of damage to the employee's principal residence.
The poster WILL pay taxes and WILL pay a penalty. At no time did I say otherwise. Nor does it appear that the poster thought otherwise.
The question is, what will happen if he takes the money, claiming it's for the payment of the primary residence (permissible) and then uses it for something else? And I said that he can be seriously burned if he gets caught. It is barely possible that the IRS won't notice when he pays his taxes or the DOL question it when (and it is when, not if) the plan is audited, but I wouldn't bet the rent on it.
Consider. A few years ago, I didn't know if certain income I had received was taxable or not. I called the IRS while I was doing my taxes and asked. THE IRS THEMSELVES TOLD ME THAT IT WAS NON-TAXABLE INCOME AND THAT I DID NOT NEED TO REPORT IT. Three years later, they contacted me and said they were wrong, I did need to report it after all, and I was charged penalties and interest over and above the tax for THEIR mistake. In this case, we are talking about a blatant disregard for the rules. So even if it gets missed in 2012, there's no guarantee it won't get caught in a subsequent year.
1.) Un-reimbursed medical expenses for you, your spouse, or dependents.
2.) Purchase of an employee's principal residence.
3.) Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
4.) Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
5.) For funeral expenses.
6.) Certain expenses for the repair of damage to the employee's principal residence.
The poster WILL pay taxes and WILL pay a penalty. At no time did I say otherwise. Nor does it appear that the poster thought otherwise.
The question is, what will happen if he takes the money, claiming it's for the payment of the primary residence (permissible) and then uses it for something else? And I said that he can be seriously burned if he gets caught. It is barely possible that the IRS won't notice when he pays his taxes or the DOL question it when (and it is when, not if) the plan is audited, but I wouldn't bet the rent on it.
Consider. A few years ago, I didn't know if certain income I had received was taxable or not. I called the IRS while I was doing my taxes and asked. THE IRS THEMSELVES TOLD ME THAT IT WAS NON-TAXABLE INCOME AND THAT I DID NOT NEED TO REPORT IT. Three years later, they contacted me and said they were wrong, I did need to report it after all, and I was charged penalties and interest over and above the tax for THEIR mistake. In this case, we are talking about a blatant disregard for the rules. So even if it gets missed in 2012, there's no guarantee it won't get caught in a subsequent year.
I didn't quote you as saying that however another senior poster did state that.
I direct you to the OP comment
The IRS doesn't care. I'm telling you, they don't care. It's not their issue. DOL will care, however if the administrator performed due diligence in approving the distribution there will be no penalty to the employer, the custodian, or the plan.
Most penalties are not negligence based they are percentage based. The IRS has also long made it clear that you cannot rely on non-written advice from them as a defense against penalty (however I suspect had you protested the penalty they would have backed off). With regards to the OP, I'm not sure what you're getting at. Aside from paying the tax and addition to tax for early distribution there are no other ramifications that could come.
cbg
I'm a Northern Girl
So it is your position that despite the fact that the IRS set up very strict regulations as to what a hardship withdrawal can be used for, they don't care whether those very strict regulations are followed or not?
If that's your position, fine. But my position is that if the OP takes that advice, they do so at their own risk. I ran this OP's question past my former boss, who works for one of the ten biggest law firms in the US and who knows these regs so well, the ERISA lawyers come down to consult with her. The words, "seriously burned" in my response upthread are hers.
But it's no skin off my nose. The OP is free to do what he wants - I'm not the one who'll have to pay the fines and penalties.
If that's your position, fine. But my position is that if the OP takes that advice, they do so at their own risk. I ran this OP's question past my former boss, who works for one of the ten biggest law firms in the US and who knows these regs so well, the ERISA lawyers come down to consult with her. The words, "seriously burned" in my response upthread are hers.
But it's no skin off my nose. The OP is free to do what he wants - I'm not the one who'll have to pay the fines and penalties.
Thanks for the responses everyone. It appears I have started a nice debate... To clarify a few things...
-I intend to fully report this distribution as an early withdrawal, pay the 10% penalty and pay any applicable taxes.
- I work with a large corporation that uses a major 401k provider. In speaking with my benefits department they have told me all hardships are handled by the provider. No documentation is required by my company. The 401k provider simply asks me a few questions during a recorded conversation like the amount I need the purpose of the withdrawal. Then boom the money is in my checking account the next day. They state I need to keep all my docs..purchase agreement, settlement statement etc for tax purposes.
- being that this is a major 401k provider I am assuming they have done their due diligence and recording the conversation is sufficient to meet any regulations. So I highly doubt I am putting my companies program at risk with my actions.
- to the member that says the consequences will be dire or I could be severely burned. Those words are general and situational but don't really help me. To me severely burned is 50-100% in additional penalties... Dire would mean they would do me like Wesley Snipes. A punch in the gut which I would be willing to accept...10-20% in penalties on top of what I already paid. I would think the punishment needs to fit the crime but this is the IRS.
-I realize I am paying huge penalties but this would leave me free of non mortgage debt and allow me to continue living within my means at my current pay. I would still have more than half my original savings left and have almost 30 years left to save for retirement. I am in an industry that would make it tough to find another job(if I had to) if I were to file BK so that is the last possible option.
-anyone who has gone through the home buying process knows there is a myriad of problems that could arise after the time that a purchase agreement is signed that could prevent you from closing. So if you take the distribution will the full intent of buying and something happens that makes the transaction fall apart.... is that something that you should be 'severely burned' for or suffer 'dire' consequences? There is no opportunity to roll these funds over so that is a legitimate situation that someone may find themselves in.
-I intend to fully report this distribution as an early withdrawal, pay the 10% penalty and pay any applicable taxes.
- I work with a large corporation that uses a major 401k provider. In speaking with my benefits department they have told me all hardships are handled by the provider. No documentation is required by my company. The 401k provider simply asks me a few questions during a recorded conversation like the amount I need the purpose of the withdrawal. Then boom the money is in my checking account the next day. They state I need to keep all my docs..purchase agreement, settlement statement etc for tax purposes.
- being that this is a major 401k provider I am assuming they have done their due diligence and recording the conversation is sufficient to meet any regulations. So I highly doubt I am putting my companies program at risk with my actions.
- to the member that says the consequences will be dire or I could be severely burned. Those words are general and situational but don't really help me. To me severely burned is 50-100% in additional penalties... Dire would mean they would do me like Wesley Snipes. A punch in the gut which I would be willing to accept...10-20% in penalties on top of what I already paid. I would think the punishment needs to fit the crime but this is the IRS.
-I realize I am paying huge penalties but this would leave me free of non mortgage debt and allow me to continue living within my means at my current pay. I would still have more than half my original savings left and have almost 30 years left to save for retirement. I am in an industry that would make it tough to find another job(if I had to) if I were to file BK so that is the last possible option.
-anyone who has gone through the home buying process knows there is a myriad of problems that could arise after the time that a purchase agreement is signed that could prevent you from closing. So if you take the distribution will the full intent of buying and something happens that makes the transaction fall apart.... is that something that you should be 'severely burned' for or suffer 'dire' consequences? There is no opportunity to roll these funds over so that is a legitimate situation that someone may find themselves in.
mercedestiffany
Junior Member
Except that you are not attempting to purchase a primary residence. You are taking a deduction that would otherwise be prohibited, KNOWING that you do not intend to use it for the allowable purpose. Can you say, Fraud?
Let me get this straight, and I'm new to this site having googled this same post as a question, so what you are saying is that this person is fradulantly obtain his/her own money???
I'm not a good saver, that said, I elected for the 401k and I too am thinking of fradulantly obtaining some of MY MONEY out of my 401k. You can get a letter from your mortgage company when you've fallen behind on you payments to submit to your 401k in an attempt to tap into funds to save your home. I plan on doing that and instead doing a short sale and using the funds as downpayment for my mother-n-law to purchase the home in a short sale Instead of being upside down (owing $167 on a property that is now only acessed at $122) My mother-n-law can purchase it for about $60,000 and my mortgage will then be afforadable and I can keep it and live comfortably again. I've included it on a chapter 7 bankruptcy already, so it will not effect my credit and the short sale will avoid me having a forclosure on my report. I plan to use the $6,000 I'm taking as a hardship from my 401k to give to her as the 10% down on the home. So am I so horrible to take this money, MY MONEY, and essentially work the system a bit to my favor to keep my home and not be upside down in it, or is it "the right thing to do" and allow it to go into forclosure, become the banks problem, further negatively effecting the economy? Oh, and, it's a duplex, so I'd also have a family with 2 little kids homeless???
Thank you to the person who is saying, what makes sense to me, that the only thing the IRS is really concerned about ultimately is getting there 10% on penelties/fees etc... which I certainly intend on paying/reporting. I think it's crap that you can't access your money for whatever reason and just pay the damn penelty and be done.
Let me get this straight, and I'm new to this site having googled this same post as a question, so what you are saying is that this person is fradulantly obtain his/her own money???
I'm not a good saver, that said, I elected for the 401k and I too am thinking of fradulantly obtaining some of MY MONEY out of my 401k. You can get a letter from your mortgage company when you've fallen behind on you payments to submit to your 401k in an attempt to tap into funds to save your home. I plan on doing that and instead doing a short sale and using the funds as downpayment for my mother-n-law to purchase the home in a short sale Instead of being upside down (owing $167 on a property that is now only acessed at $122) My mother-n-law can purchase it for about $60,000 and my mortgage will then be afforadable and I can keep it and live comfortably again. I've included it on a chapter 7 bankruptcy already, so it will not effect my credit and the short sale will avoid me having a forclosure on my report. I plan to use the $6,000 I'm taking as a hardship from my 401k to give to her as the 10% down on the home. So am I so horrible to take this money, MY MONEY, and essentially work the system a bit to my favor to keep my home and not be upside down in it, or is it "the right thing to do" and allow it to go into forclosure, become the banks problem, further negatively effecting the economy? Oh, and, it's a duplex, so I'd also have a family with 2 little kids homeless???
Thank you to the person who is saying, what makes sense to me, that the only thing the IRS is really concerned about ultimately is getting there 10% on penelties/fees etc... which I certainly intend on paying/reporting. I think it's crap that you can't access your money for whatever reason and just pay the damn penelty and be done.
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