Do you have to pay taxes on 401k withdrawal for home purchase

The answer here depends on your situation and reason for taking a distribution. Whether you’re moving money to a new retirement plan, taking money out for retirement, or making a withdrawal to pay expenses, you’ll want to understand the tax implications of your 401(k) distribution. 

Moving the money to a new plan, such as an IRA or a new employer 401(k) is known as a rollover. This type of move can be taxable if the money is sent to you versus the financial institution. 

• If you’re moving your retirement savings funds to a new plan through a direct rollover, no tax reporting is necessary.
• If your plan is sending you the money first (an indirect rollover), there’s more to the story.

Find out more about both direct and indirect rollovers in our 401(k) rollover to IRA article.

What if you’re not rolling over your 401(k) and it is simply time to use the funds? Read on and we’ll outline everything else you need to know about taxes on a 401(k) distribution.

When can you withdraw from a 401(k)?

Retirement plans are designed so that you can use the money when you reach retirement. For this reason, rules restrict you from taking distributions before age 59½. You can take money out before you reach that age. However, that generally means you’ll have a 10% additional tax penalty unless you meet one of the exceptions such as taking a 401(k) withdrawal due to coronavirus impacts.

If you’re taking out funds from your retirement account prior to 59½  (and the coronavirus exception or other exceptions don’t apply), use IRS Form 5329 to report the amount of 10% additional tax you owe on an early distribution or to claim an exception to the 10% additional tax.

Find additional exceptions in the Form 5329 Instructions.

401(k) distribution tax form

When you take a distribution from your 401(k), your retirement plan will send you a Form 1099-R. This tax form shows how much you withdrew overall and the 20% in federal taxes withheld from the distribution. This tax form for 401(k) distribution is sent when you’ve made a distribution of $10 or more.

How does a 401(k) withdrawal affect your tax return?

Once you start withdrawing from your 401(k) or traditional IRA, your withdrawals are taxed as ordinary income. You’ll report the taxable part of your distribution directly on your Form 1040.

Keep in mind, the tax considerations for a Roth 401(k) or Roth IRA are different. To find see the difference side-by-side, check out this table from the IRS.

Do you pay taxes twice on 401(k) withdrawals?

We see this question on occasion and understand why it may seem this way. But, no, you don’t pay taxes twice on 401(k) withdrawals. With the 20% withholding on your distribution, you’re essentially paying part of your taxes upfront.

Depending on your tax situation, the amount withheld might not be enough to cover your full tax liability. In that case, you’ll have to pay the rest of the tax when you file your return.

If the opposite is true and you’ve paid more than you owe, you’ll get a little back at tax time. Either way, you would not pay the same tax twice on your 401(k) withdrawal.

Need more help with 401(k) distribution taxes or other retirement account questions?

Tax laws for retirement savings accounts can get complicated. Don’t try to navigate complicated tax code yourself. Get help! Whether you use a tax pro at one of our H&R Block office locations or file online, we can help you maximize your tax savings.

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It’s a fact: The housing market is hot and competition for homes is becoming increasingly intense. While entering the market is nerve-racking for most buyers, it can be especially stressful for first-time homebuyers who are trying to come up with the necessary funds to make a down payment. This has led some first time home buyers to look toward non-traditional sources – such as their 401(k) – to come up with the money they need.

Here, we’ll examine how to, and if you should, make a 401(k) withdrawal to use as a source for a down payment as a first-time homebuyer.

Can a 401(k) help you make a down payment?

The short answer is yes. The longer answer is yes, but…

First things first – your 401(k) is your money to use at your discretion. While it doesn’t function the same way as a standard deposit account, you still have the right to access it if you choose to do so. If you’re like many, your 401(k) is your largest financial account, and it can certainly be tempting to use these funds as the source of your down payment. However, there are some distinct drawbacks to this strategy, including penalties, taxes, and potential repayment requirements.

By design, your 401(k) is a retirement account meant to last you well into your golden years, so you shouldn’t just freely dip into it here and there. Until you turn 59 ½ (or 55 if you’re no longer working), there is a 10% early withdrawal penalty on any money you take out. Additionally, you will have to pay income tax on the amount withdrawn.

Typically, those who decide to use their 401(k) as a down payment source are first-time homebuyers who likely don’t have the savings or assets to make a down payment otherwise.

If you’ve weighed the pros and cons and believe using the funds in your 401(k) is the best choice for you, you have two options for accessing your money.

• 401(k) Loan: In this scenario, you are simply borrowing from yourself. All funds you withdraw will have to be repaid with interest (typically the prime rate, plus 1-2 interest points).
• 401(k) Withdrawal: By withdrawing money, you avoid any repayment requirements. However, you will incur a 10% penalty and be required to pay income tax on the amount withdrawn.

Let’s take a deeper look into each of these options.

401(k) Loans

Because of the penalties and taxes assessed to 401(k) withdrawals, a 401(k) loan is likely to be the lower-cost option.

Generally, these loans aren’t reported to credit bureaus, so they’re unlikely to affect the debt-to-income ratios that are evaluated to determine mortgage qualifications. However, depending on the loan type you’re applying for, this may not necessarily be the case. As always, it’s best to work alongside a qualified Loan Officer when securing funding for a home purchase.

There are also some downsides and potential risks associated with 401(k) loans. First, you won’t be able to make any new contributions while you’re paying off your loan, and your employer won’t be contributing either. Compound that with the potential interest you’re missing out on, and it could make a pretty big impact on your retirement savings.

Generally, 401(k) loans are repaid over five years, though when used for home loans the repayment period can sometimes be longer. However, it’s important to note that if you leave your current job, you will be required to repay the loan in its entirety by the next year’s tax filing date. Any money not repaid by the due date will be considered a withdrawal and is subject to all penalties and taxes that entails.

401(k) Withdrawals

Unlike a 401(k) loan, 401(k) withdrawals don’t come with any repayment requirements. However, they do come with the penalties and taxes mentioned above. Also, you lose the security of knowing that this money will be paid back to your account for retirement.

Before you decide to take this approach, we strongly recommend that you speak with a Loan Officer or other financial professional for complete details and information about other options that may be available.

Can you use your 401k to buy a house without penalty in 2022?

There are limits to how much you can withdraw from your 401(k), so likely you won’t be able to purchase your house outright. Typically, this limit is 50% of your 401(k)’s vested account balance or $50,000, whichever is less. And of course, if you choose to make a withdrawal, all penalties and taxes would apply.

Because of this limit, if you do decide to dip into your 401(k), it is best used as a down payment source.

Are there other options?

Certainly! We encourage you to talk to a New American Funding Loan Officer to learn about other Conventional loans and government-sponsored programs (including low- and no-down payment options) that could help you get into your new home.

Additionally, we offer a mortgage calculator that can help you begin thinking about your budget.

If you’re in the market for a new home or simply want to discuss your financing options a first-time homebuyer, we’d love to hear from you today!

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