Wednesday, February 3, 2010

Penalty for saving home with 401(k)?

When you're struggling to pay the mortgage, the stash in a 401(k) retirement plan can look pretty enticing. So what became of the ’08 discussion about partially suspending the hefty penalty for early withdrawals of 401(k) money?

Fair question, given the rising wave of mortgage delinquencies and threat of foreclosure.

Short answer: Hasn’t happened.

Where it started: Late in 2008, then President-elect Obama included the penalty easing proposal in an early economic revitalization plan. People would be “facing unique economic hardship,” according to http://change.gov/agenda/economy_agenda/. The plan called for legislation that would waive the penalty on limited withdrawals "to help these families pay their bills and their mortgages and make it through these tough times."

PolitiFact.com, a Pulitzer winning site from the St. Petersburg Times, rated the issue a "Promise Broken" last year. http://www.politifact.com/truth-o-meter/promises/promise/508/allow-penalty-free-hardship-withdrawals-from-retir/

And it popped up again, just last week, when President Obama and Vice President Biden spoke at a town hall meeting in Tampa. A participant noted that tough economic times are forcing many people to make 401(k) withdrawals, and they can’t afford the penalty.

Obama responded that the penalty is in place “because you’re getting that money tax-free, the idea being that you’re going to actually use it for retirement. And then if you’re spending it early, before retirement, then you can imagine that a lot of people could potentially game the system by using these accounts to avoid taxes,” according to a transcript (http://www.whitehouse.gov/the-press-office/remarks-president-and-vice-president-town-hall-meeting-tampa-florida).

However, the President said the point is legitimate. “Blanket amnesties in all circumstances may not be possible,” he said. “But taking a look at certain narrow categories of emergencies in which these penalties could be waived is something that we have discussed and I think we could explore.”

Ed Ferrigno, who heads government relations for the Profit Sharing/401K Council of America, said most years someone in Congress calls for waiving the penalty for some reason. But the idea never gets much mainstream support. The only exception he recalls was for victims of the massively disastrous Hurricane Katrina.

The plans allow people to sock away money before taxes. In exchange for the tax break, you have to leave the money alone until you’re at least 59.5 years old. There are exceptions, including hardship withdrawals. See IRS site http://www.irs.gov/retirement/article/0,,id=162416,00.html for details.

But if you make a withdrawal, you pay regular income taxes and a penalty of 10 percent of the amount withdrawn.

The penalty is a way to “put discipline into the system,” says Ferrigno, whose group represents employers offering the retirement plans. At the same time, allowing withdrawals recognizes that sometimes “the best intentioned people have to re-evaluate their situation.”

Another option is to take a loan against your 401(k), which can be more restrictive but avoids the penalty, as long as it is repaid.

Obama added during the town hall that he has personally experienced the penalty’s pain. He said some years ago, when working in a law firm, the family had emergency needs. He made a retirement plan withdrawal and paid the penalty. “No fun,” he told town hall attendees. “But it was what we had to do.”

He and his wife were young enough to absorb the hit, he said, but acknowledged it would be a greater hardship for a lot of families.

What do you think Save Your Home readers? Should people facing foreclosure get a break on the hardship penalty?

And a request: If you’re struggling with foreclosure, please contact me directly. Call 704-358-5173 or e-mail me at shopkins@charlotteobserver.com. Thanks.

11 comments:

Anonymous said...

No. In most cases people are withdrawing money to pay past due amounts and hope they can find some work to later forclose and then find they've depleted their retirement accounts as well.

FYI - retirement accounts are protected from bankruptcy.

Don't do it.

Anonymous said...

I am one of those who withdrew money (51K in my case)from a retirement account and paid off my mortgage. I was laid off my job and have been unemployed over a year. My mortgage was not one of the mortgages that has caused so many problems. I had a reasonable, fixed rate mortgage. Over the years when I was employed, I paid an additional amount on my principal many months. I even worked part time jobs (in addition to my full time job) for many years and used that part time income to pay down the principal on my mortgage. My home was not in foreclosure when I paid it off and my mortgage payment was current. But I knew it was just a matter of time before foreclosure would be staring me in the face. The stress of unemployment is bad enough. I couldn't handle the additional stress of foreclosure and homelessness. I think citizens who can show they are unemployed and have withdrawn money from a retirement account that has been used to make monthly mortgage payments or paid off a mortgage completely, should receive a waiver of the 10% early withdrawal penalty that the IRS imposes. We should only pay income taxes on the money. I am not very hopeful that Congress and President Obama will do the right thing and help citizens like me. Politicians make all kinds of promises when running for office. But they develop amnesia once they are in office. When I read some of the heartbreaking stories of my fellow unemployed citizens (who have jumped through all kinds of hoops when dealing with their lender and organizations that are supposed to help them save their homes), I know withdrawing the 51K from my retirement account and paying off my mortgage, was the right decision for me.

Anonymous said...

So many friends and family have already dabbled in their investments. Some just to feed their families..but mostly to pay the mortgage, and other bills.

All the same the penalty was part of the process when you signed on your 401, I say leave the penalties, to deter the urge for early withdrawal, and find another way.

More bailouts and "stimuless" programs at this point will do nothing but make the economy worse, long term.

Kind of like the idea of drawing down retirement accounts, it helps now ...maybe...but then what?

You will be more broke and hurting years down the road, and probably beyond help when your working years are over, and be standing in government assistance lines.

Anonymous said...

I think the issue may be the waffling of eople we are supposed to trust.

Anonymous said...

Have to admit 2:42 nailed it.

I interpret that comment as such...

As a small business owner, and previously in the market home buyer the only thing that makes much sense is to not do much. Until there is some toning down of the 'new government' that is clearly out of control with needless spending and clearly out of step with mainstream America
we aren't dong anything major.

Business is fine but why expand when the prediction of taxes, regulations, governmental health care
requirements and other things that effect the day
to day operation of small business are so completely in the blender of doubt ?

That includes buying a house
we qualified but decided not to go there...yet.

dingo said...

I do not favor waiving the penalty for early withdrawals from a 401-K account. First, why is "saving a home" more important than saving for retirement? Isn't it in society's best interests to help people enter old age with adequate savings? Spending our future for the sake of the moment makes little sense in the long term.

Second, many people in trouble with mortgages are in homes they should not be in. Help for them means moving to a less expensive home, with payments they can afford. People won't need 401-K funds to do that. Simply walk away from the unaffordable home and rent an affordable one. The foreclosure and bankruptcy which follow cannot touch your 401-K!

The most disturbing aspect of this article is the author's suggestion that people should move money from where it is beyond the reach of banks and creditors, over to a place where it is in reach.

I'll give you one guess who that move will help, and it is not the homeowner. Don't be fooled. Don't touch your 401-K!

Anonymous said...

Anon @February 3, 2010 1:31 PM

I see nothing wrong with paying off your mortgage. It has to be paid off someday anyway, whether now or in your "retirement" years.

However, when the money went into the retirement account, you and everyone else knew that if you withdrew the funds before 59.5, you were looking at a 10% penalty. No one said there would be an exception if someone lost their job and wanted to pay off the mortgage.

That was the trade-off. Get tax-deferred growth vs potential penalty. Not only did your contributions earn money, but your earnings on that money earned money.

It's a tough decision. But even with the tax penalty, you knew it was the right one for you. Now, if you can at all, start putting money back into some kind of retirement vehicle.

Stella Hopkins said...

A gentle reminder: Discussion and disagreement welcome but please, no name calling, racial or ethnic slurs or blatant untruths. Such comments will be rejected. Thanks.

Anonymous said...

(to 51k in 401k) It seems like the biggest crisis in the world losing your job and being afraid of losing your house I am sure. I don’t want to come off as someone who is not sensitive to that. It is my greatest fear. That is one of the reasons why my savings other than my 401k is more than the total of my mortgage. Maybe if you were as afraid of your situation as I am you would have more of a buffer when you lost your job. For years I bought only cars I could afford and lived in a house below the “standard” of others in my income bracket. You made no mention of the value of your house or your income or savings so that is not really up for discussion.

But one thing is clear to me. Many people never see the future as something they will have to face only the present. So now you have no mortgage and your problems are over right? What about up keep on your house? What about taxes? What about heat, cooling, etc. What about a new roof? What about insurance against fire, theft, etc.

Exactly what are you going to do in retirement to keep your house when the bills OTHER THAN a mortgage come due? You can still lose your house.

A sensible financial solution to consider is to match your current income situation with a home you can afford (and if that is mobile home then that is what you can afford) not a home you want that you USE to be able to afford when you could work 2 jobs to pay your mortgage. You needed that 401k money to fix the roof and make sure you have a heat source if it breaks down when you are 75+. That is true weather you can or should get a tax break to use your 401k or not.

Your kidding yourself if you don’t see that (or you think SS will be much help). Now maybe the cost of buying and selling a house outstrip any savings you would have realized and it makes no sense to do that. But you made no discussion of that even as an option you considered. I don’t see you thinking long term.

And now you want a tax break?

So tax payers (me) should fund your bad luck and poor planning so you can live to a higher standard than your income allows for? Your asking for a handout….and maybe you should get one….but I don’t think your all THAT different than the executives at AIG (other than your probably a poorer and nicer guy who is more honest) but has still made poor choices and had bad luck that you want me to pay for.

John said...

The President's argument falls flat when you consider that you STILL pay taxes on the money when you withdraw it, so it really doesn't matter WHEN you withdraw it you still pay. So the 10% penalty isn't really justified because the amount you withdraw is not just what you put in but also the earnings on that investment so the income tax you pay is the same either way. Once again, this President just said one thing when he was running for election and totally reversed his positions on most things once he had the votes. Joe Wilson was right last year... Obama lied!

Anonymous said...

I hope that millions, nay, tens of millions of hard-working Americans empty their 401K accounts all in one day simultaneously so that it'll crash the corrupt stock markets along with all of the mega banks.

The best retirement plan is close ties to your family and nice next-door neighbors -- people should take care of each other, and we shouldn't have to rely on some corrupt stock market account to eat and heat our homes when we are old.