AboutGina Boykin Expertise Financial planning, debt management & credit cards, and money-saving tips for adults and teens. Saving vehicles such as CDs, treasuries, bonds, and money-market funds. I provide honest, objective and relevant information to help you made the best decision for your money.
Experience Over 10 years of combined experience in accounting, audit, investing, entrepreneurship, real estate.
I am the CEO of Atlanta Y.E.S., a nonprofit organization dedicated to financial literacy for youth.
Education/Credentials B.S. Accounting, 10 years of experience in accounting, audit, and investing
Expert: Gina Boykin Date: 11/26/2007 Subject: Saving for a house
Question Hello,
My fiance and I are looking to save for our first home. He thinks I should put money away in a 403B through my organization (non-profit) and withdraw it in a year and a half when we are ready to buy. He said there are breaks for first time buyers. My question is what would be the best vehicle to invest my money for early withdraw where I can still get a good return on my money and not have large tax penalties?
Also, we will be withdrawing from 2 other 401K's for the house. IS there a limit on the number of 401K's you can withdraw from at one time while still getting the tax break?
Thanks!
Answer A 401K or 403B is actually the LAST place you want to go to take out money for a home. If you are contributing to one now with the expectation to withdraw it in a few years, you should stop those contributions as well. Here's why:
#1 - You end up with a lot less than you take out. The IRS does allow withdrawals for 1st time home buyers. It is called a "financial hardship withdrawal". However, it does not classify as a penalty-free hardship withdrawal. Penalty-free withdrawals are for real hardships, such as becoming totally disabled or needing the money for significant medical expenses. The IRS says it is doing you a favor by letting you take the money out - but don't think you get it for free! The money you withdraw is subject to regular income taxes (federal and state) and a 10 percent penalty. For example, if you plan to withdraw $10,000, and you are in the 30percent tax bracket, you will owe $3,000 and only receive a benefit of $7,000. Your employer will most likely take out an estimated amount for taxes and penalties at the withdrawal and you will receive the net amount.
The penalty alone will most likely wipe out most of your gains over the next year or two, and you lose the tax benefit of contributions you've made over the years.
#2 You can't pay it back. If you come up with the money somewhere else later, you can't put it back in your 401K to avoid taxes and penalties.
#3 It defers future contributions. Most employers use the "self certification" approach, which means that you don't have to provide proof that you need the hardship withdrawal, but then you can't make contributions for 6 months after you take the withdrawal.
You do have some alternatives for the money you have in the 401K's and for your future contributions.
Option 1 - A loan. You can take a loan from your 401K. There are no taxes or penalties when you take a loan. The interest that is charged on your loan is actually paid into your account (instead of paying interest to a bank, you are actually paying yourself the interest). Also, you can continue to contribute while you pay the loan back. However, if you leave the company while the loan is outstanding, the loan becomes immediately due. If you don't pay it back within the timeframe required, it will be considered a withdrawal and you will have to pay taxes and penalties.
Option 2 - Contribute to an IRA. For a traditional IRA, each spouse can withdraw up to $10,000 for a 1st time home purchase without penalty. However, you will still owe taxes, because IRA contributions are tax-exempt. For a Roth IRA, there is no limit. You can withdraw all of your contributions without penalty; however, only after the account has been opened for 5 years. Since Roth IRA contributions are done with after-tax money, there are no additional taxes to pay.
Option 3 - Rollover your 401K. You mentioned that you are withdrawing from 2 other 401K's. Is one of these from a former employer? If so, you can rollover this account to a traditional IRA or a Roth IRA. If you roll it over to a traditional IRA, there are no fees associated with the rollover. Then you will be able to withdraw $10K without penalty, as stated above.
You can take another step, and rollover to a Roth IRA (it has to be rolled over to a traditional IRA first - there are no direct rollovers). Since Roth IRAs are after-tax retirement accounts, this means that the entire amount of your rollover will be reduced by income taxes. HOWEVER, remember that Roth IRAs grow tax-free. Although you may lose 25-35percent in taxes during the rollover, think of how much your account will gain over the next 30 years. All of these earnings will are tax-free.
With Roth IRAs, you can then withdraw any amount of your contributions without penalty. However, the 5-year rule still applies.
Option 4 - Invest in non-retirement accounts. Your timeframe of 18 months is really not long enough for stock and bond investments. These are long-term investments (more than 5 years). Instead of investing in a 403B, you should place the money in a regular savings account or CD. It's boring, I know, but it's safer than investing in something that could decline when you need it most!
