While it is possible to use your 401k to buy a house, there can be significant downsides to this course of action.  Keep reading to find out everything you need to know about using your 401k to buy a house.

Making a 401k hardship withdrawal

401k plans are intended for retirement savings.  So, if you want to take money out of your 401k plan early, there are penalties and taxes in place to deter you.

Congress did make provision in the 401k plan rules to allow you to access their savings in extreme circumstances.  However, the rules don’t allow you to take money simply because you’re inconvenienced.  You have to prove you need the money for a certain purpose such as paying funeral expenses or buying a main residence.

In addition, if you are younger than 59 ½, any money that you withdraw from your 401k to buy a house is subject to the appropriate income taxes.  You will also pay a 10 per cent ‘early withdrawal penalty’.

Keep in mind also that your employer does not have to offer the ability to make a hardship withdrawal.  You should therefore check that such a withdrawal is available to you.

A 401k loan

An alternative to making a 401k hardship withdrawal to buy a house is to consider a 401k loan.

Most 401k loans are agreed regardless of your needs and it can be very easy to obtain a loan against your retirement plan.  When you borrow from your 401k plan you also benefit from the interest that you pay.  This is because the interest that you pay goes back into your 401k plan.  For example, if you borrow $4,000 and pay back $4,750 in total, the extra $750 goes into your plan.

However, there are also disadvantages of borrowing from your 401k to buy a house.  You may have to pay fees for the loan and you will be foregoing some funds from benefiting from tax deferred growth.

In addition, if you default on your 401k loan payment it is treated as a distribution.  This means that your money is taxed and you have to pay the 10 per cent early withdrawal penalty if you are aged under 59.5.

Using your 401k to buy a house

In summary, the answer to the question ‘can I use my 401k to buy a house’, the answer is ‘yes’.  However, for the reasons mentioned above the costs may not be worth it.  You may be better considering other options such as borrowing money from friends of family or delaying your house purchase until you can save up more of a downpayment.

This is because, whenever you leave your job, you have a decision to make with regards to your 401k plan.  Typically many people elect to rollover their 401k to a traditional IRA (Individual Retirement Arrangement).  However, it’s also possible to consider a rollover to a Roth IRA.  Keep reading for our guide to how you can roll your 401k to a Roth IRA.

What is a Roth IRA?

A Roth IRA is a special type of retirement plan under US law that is generally not taxed, provided certain conditions are met.  This type of scheme was established by the Taxpayer Relief Act of 1997 and named after its chief legislative sponsor, Senator William Roth of Delaware.

In contrast to a traditional IRA, contributions to a Roth IRA are not tax-deductible.  Withdrawals are generally but not always tax-free and there are certain stipulations.  For example, you have to be aged at least 59 1/2 for tax free withdrawals on the growth portion above principal.

An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements. Transactions inside an account (including dividends, capital gains and interest) do not incur a current tax liability.

Can I roll my 401k to a Roth IRA?

The simple answer to this question is ‘generally, yes’.

However, remember that you must be separated from your employer to roll your 401k into a Roth IRA.  You cannot do this if you are still working for the same company and/or employer unless you are aged over 59 ½.

The process for rolling your 401k into a Roth IRA was simplified in 2008.  Prior to this, you were simply not able to directly rollover your 401k into a Roth IRA.   If you wanted to do so you had to complete a two-step process.   You had to open a traditional IRA and then convert the traditional IRA into a Roth IRA which as a long-winded and complicated process.

However, just because the law changes made it available to rollover your 401k plan into a Roth IRA doesn’t mean that you can always do it.  Whether you can rollover depends on your plan administrator.  And, keep in mind that you have to have a Roth IRA already established.

To this day, many 401k’s and 403b’s have had the same ‘No-Roth IRA Rollover’ option.  This option is supposed to be mandatory in 2010, but some plans still do it on a voluntary basis.

So, starting in 2010, anybody was able to take all their traditional IRA’s and old retirement plans (401ks) and convert them to a Roth IRA.  The amount that you convert will be taxed, but it still can be an attractive move for you if you that feel that taxes are going nowhere but up.

The simple answer to the question ‘when can I take money out of my 401k?’ is ‘at any time’.  However, if you’re under the age of 59 ½ then you may end up paying penalties.  Keep reading to find out the consequences if you want to withdraw from your 401k plan.

Taking money out of your 401k on retirement

The standard age for taking cash out of your 401k plan is 59 ½.  So, if you are over that age then you can take your money out as dispersals and you’ll just pay standard income tax.

When you can take money out of your 401k early without penalty

There are other situations where you can withdraw cash from your 401k plan before the age of 59 ½ without paying a penalty. Such situations include:

• You become permanently disabled
• You die and the account is paid to your beneficiary/estate
• You make an allowable medical expense deduction (where your medical expenses exceed 7.5 per cent of your adjusted gross income)
• You’re separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turned 55 or later
• You have to pay a levy on the 401k plan itself

In these instances the normal income tax rules apply, but you won’t pay a penalty.

Taking money out of your 401k at other times

If you’re under the age of 59 ½ and you want to take money out of your 401k plan for any other reason, you will generally pay a 10% withdrawal penalty in addition to any income tax that is applicable.

CNN reports that ‘David Wray, president of the Profit Sharing/401(k) Council of America, said that people making hardship withdrawals could pay a penalty of up to 40 per cent, once state and federal taxes are added to the 10 per cent penalty.’

Other factors to consider if you want to take money out of a 401k

As well as the potential tax and penalty implications, there are other factors you should take into account before you take money out of your 401k.

Firstly, withdrawing money means that you will be sacrificing the benefit of an earlier 401k plan contribution and you will lose all the potential future investment growth of the money you withdraw.

Secondly, you can’t make up these contributions at a later date and so you may find you receive a smaller income in retirement than you had planned for.  Finally, you will also be giving up excellent tax benefits (your contribution is tax deductible and the growth of your account is tax deferred).

Investment house Fidelity reported that 2.2 per cent of all their 401k participants had made a withdrawal at some point in 2010, up from 2 per cent in 2009.

A Mercer 401k is one of the most popular 401k plans in the US and so our guide asks the question ‘Can I withdraw from my Mercer 401k?’

The Mercer 401k

Mercer is a name that is known and trusted in the financial sector and they offer a number of plans that can be tailored to fit a company and an employee’s needs.

The 401k plans offered by Mercer generally include the standard 401k benefits and defined employee contributions.  Employer matching can be a feature up to a defined percentage, and the maximum amount of contributions allowed by the IRS can be made each year.

Many employers choose Mercer 401k plans because Mercer has a global reputation for retirement investment and for excellent customer service and financial advice.

Can I Withdraw From My Mercer 401k?

It is possible to withdraw from your Mercer 401k plan although you will normally pay a penalty for doing so.  This is an additional 10 per cent early distribution penalty tax and you will generally pay it if you have not reached at least age 59 ½ when you take your distribution. This is common to all 401k plans and not unique to a Mercer 401k.

However, in certain circumstances you can make a withdrawal without paying the 10 per cent tax penalty.  If you’re under the age of 59 ½ you can take a distribution from your Mercer 401k plan if, for example:

• You become disabled
• You die and the account is paid to your beneficiary
• You make an allowable medical expense deduction
• You terminate your employment and you are over the age of 55

When you withdraw funds from your Mercer 401k you will often find that the withdrawal is taxable.  This means that not only do you have to report this as income on your federal income tax return, but you are also subject to an additional 10 per cent penalty.

CNN reports that ‘David Wray, president of the Profit Sharing/401(k) Council of America, said that people making hardship withdrawals could pay a penalty of up to 40 per cent, once state and federal taxes are added to the 10 per cent penalty.’

As well as the penalties for withdrawing from your Mercer 401k, you should also remember that the plan is designed to provide income in your retirement.  Withdrawing cash from your 401k plan early means that you are diminishing your retirement fund.  And, this is not only by the amount you withdraw but by the amount that money would have grown between now and your retirement.

Whatever your situation, our guide explains how you closeout a 401k account.  Keep reading to learn more.

Changing employers

You have several options regarding your 401k plan when you change employers.  You can choose to rollover your 401k account to your new employer’s 401k by telling your plan administrator.  You will also have to complete some paperwork.

You can also elect to leave your 401k plan with your former employer, although this is not always recommended.

Your third option is to rollover your 401k into a new retirement savings plan such as an IRA (see below).

Finally, you can choose to closeout your 401k plan and withdraw the money.  However, there may be taxes and penalties for this as we will see shortly.

Rolling your 401k into a new savings plan

As of 2011, the IRS gives you 60 days to make a choice as to what you will do with the funds from your 401k plan before you start to incur taxes and penalties.  You therefore have to make a relatively quick decision.

If you close out your 401k account and immediately roll it over to a new retirement account (such as an IRA) in the allotted time frame, you will incur no fees on your funds.  Our guide to rolling over your 401k plan will help.

Closing a 401k account and withdrawing the cash

When you closeout your 401k plan you will generally pay penalties and taxes on the cash you withdraw.

However, for 401k plans the IRS will allow a penalty-free withdrawal if you fall into one or more of the following categories:

• Withdrawals paid to the IRS to pay a levy on the 401k plan itself
• Withdrawals made because you have been permanently disabled
• Withdrawals made to your estate after your death
• Withdrawals where your medical expenses exceed 7.5 per cent of your adjusted gross income

Other withdrawals will generally be subject to taxes and penalties if you are under the age of 59 ½.

Firstly, you will pay a 10% withdrawal penalty for closing out your 401k plan early (in this case ‘early’ means before the age of 59 ½).

When you withdraw funds from your 401k plan you will also often find that the withdrawal is taxable.

David Wray, president of the Profit Sharing/401(k) Council of America, has warned that people making withdrawals from a 401k plan could pay a penalty of up to 40 per cent, once state and federal taxes are added to the 10 per cent penalty.

He said: “People take a very significant hit when they take a hardship withdrawal.”

Beth McHugh, vice president of market insights for Fidelity agrees.  She told CNN: “People should be prepared, because when it comes time to do their tax filing, that money is taxed as income.  They need to make sure they keep some of that money aside so they can use it to pay their taxes instead of spending it.”

Our guide looks at four things differentiate a 401(k) plan from other retirement plans.  Keep reading to learn more.

There are limits on the amounts you can contribute

When you join a 401(k) plan, you can tell your employer how much money you want to go into the account.  You can usually put up to 15 percent of your salary into a 401(k) plan each month, but your employer does have the right to limit that amount.

The IRS limits your total annual contribution to $17,000 (for 2012).

Easy to save

Your 401(k) plan contributions come out of your paycheck before your taxes are calculated and before the money reaches you.  This makes this type of plan one of the easiest and most convenient ways to save for your retirement.

You don’t have to make contributions to your plan yourself and you won’t be tempted to miss contributions as they are deducted before you ever receive your salary.

Matched contributions and your savings are safe

If you’re lucky, your employer will match a portion of your 401k plan contribution.  This money is offered to you as an incentive to participate in the 401k scheme.  By matching some of your contributions, you are effectively building up additional savings for your retirement that you haven’t paid for.

And, the Employment Retirement Income Security Act (ERISA) that was passed in 1974 includes regulations that protect your retirement income.  This Act requires that all 401(k) plan deposits are held in custodial accounts in order to keep your money safe in the event that something happens to your employer.

The ERISA also sets out a list of requirements that your employer must follow, such as sending you regular account statements, providing easy access to your account and maintaining compliance so that the plan is fair for everyone in the company.

The Act also requires your employer to provide you with educational materials about the investment opportunities within your plan (see below).

Choice of investments

Your 401k contributions are given to a third party administrator who then invests it in mutual funds, bonds, stocks and money market accounts.  However, they don’t determine the mix of investments — you do that.  The administrator usually has a list of investment vehicles you can choose from as well as some guidelines for the level of risk you are willing to take.

However, bear in mind that there may be limited choices as to the investments you can take advantage of.  Some other retirement savings plans offer a wider choice of investments which may be more appropriate depending on your personal circumstances and the amount of risk you are prepared to take.

However, there are strict rules for making such a withdrawal and it is likely to come at a heavy cost.  It is therefore vital that you understand the implications before dipping into your retirement fund.  Keep reading to learn more.

When you can make a withdrawal

A 401k withdrawal is not like a loan from your plan.  It may be difficult to obtain and it is likely to cost you a significant amount.

However, Congress did make provision in the rules for 401k plans to let plan holders access their savings in extreme circumstances.  The rules don’t allow you to take money simply because you’re inconvenienced and you have to prove that you truly need the cash.  Such reasons include:

• Funeral expenses
• The purchase of a main residence
• To pay for medical expenses for you, your spouse or your dependents
• Payment of college tuition and related educational costs for the next 12 months for you, your spouse, dependents, or children who are no longer dependents
• Payments necessary to prevent foreclosure or eviction from your home
• Certain expenses to pay for damage repairs to your private residence

Hardship withdrawal penalties

To discourage you from dipping into your retirement fund, there are significant penalties when you make a hardship withdrawal.

If you are younger than 59 ½, any money that you withdraw is subject to the appropriate income taxes and you will also pay a 10 per cent ‘early withdrawal penalty’.  This means you could lose around 30-40 per cent of your withdrawal in taxes and penalties.

However, you may qualify for a ‘penalty free’ withdrawal if:

• A court requires you to give money to your divorced souse, a child or a dependent
• You become totally disabled
• You are separated from service (through resigning, permanent layoff, termination or early retirement) in the year that you turn 55 or later
• You owe medical expenses that are more than 7.5 per cent of your adjusted gross income

You will still pay the applicable income taxes on withdrawals under the above circumstances.

Keep in mind also that your employer does not have to offer the ability to make a hardship withdrawal.  You should therefore check that such a withdrawal is available to you.

Avoiding hardship withdrawals

If possible, you should consider other alternatives before you dip into your 401k plan.  The hardship rules will also normally require you to exhaust all other options before withdrawing from your plan.

For example, you may want to consider a 401k loan or the withdrawal of after-tax savings.

You should also remember that your 401k plan is designed to provide you with an income in retirement.  Withdrawing from your plan early will reduce the amount of savings you have available and reduce your income when you retire.  This is particularly true if you make a withdrawal at an early age as you’ll lose both the amount you withdraw and any potential growth on that money.

Two of the main retirement savings options are a 401k and an Individual Retirement Account (IRA).  Our guide looks at the main differences between these two retirement schemes and will help you choose the right plan for you.

Contributing to your plan

One of the main differences between a 401k plan and an IRA is the way in which you contribute to your plan.

With a 401k plan, your retirement savings are automatically deducted from your paycheck and placed directly into your savings account.  However, with an IRA you declare the amount of money you want to pay into your plan by using your tax form 1040.  The amount you decide on is then deducted from your taxable income.

While there may be a difference in the way you contribute, there is essentially no real difference in the way the money is deducted between both plans.

Who runs the account

There are also differences between who runs the two retirement accounts.  With a 401k, your employer will almost always sponsor the account for you.  However, in an IRA (as the ‘individual’ suggests), you have to open, fund and run the account yourself.

When you pay taxes

Another important difference between an IRA and a 401k plan relates to the way the schemes deal with pre tax dollars.

In a 401k, anything that you decide to contribute to your plan is deducted from your pay before you pay tax.  This means that you pay no tax until you start withdrawing money from the plan.

Conversely, an IRA allows you more control as to when you pay your taxes.  For example, a Roth IRA works in the opposite way to a 401k in that you pay tax on your contributions now but you don’t pay any tax when you start to withdraw the money.

Remembering the differences

The simplest way to remember the difference between a 401k plan and an IRA is to think about who controls the plan.  A 401k plan is run by your employer as they start the plan, decide what investments you can access and manage the account on a day to day basis.

With an IRA, you make all the decisions as to what and where you invest.

Opening both a 401k and an IRA

A common question is ‘can I have both a 401k plan and an IRA?’

The answer is ‘yes’ – although it depends on your situation.  If you qualify for both types of plan then it is worth taking advantage of this as it can offer ‘free money’.

Fidelity reports that 2.2 per cent of all their 401k participants had made a withdrawal at some point over the previous year, up from 2 per cent in 2009.

If you’re thinking of withdrawing from your 401k plan it’s important that you understand the implications.  Keep reading to find out more.

Understand the consequences for withdrawing from your 401k plan

While making a withdrawal from your 401k plan may seem like your only option, it is important that you understand all the ramifications.

James MacDonald, president of workplace investing for Fidelity Investments warned investors against rushing into a decision: “Taking a loan or a hardship withdrawal from their 401(k) may be their only option because it’s their only form of savings.

“However, we want to make sure that before workers tap their retirement accounts prematurely, they are fully educated about both the penalty that may be incurred and the long-term implications for their retirement.”

When you can withdraw from your 401k plan without penalty

For 401k plans the IRS allows for penalty-free withdrawals that fall into one or more of the following categories:

• Withdrawals made because you have been permanently disabled
• Withdrawals made to your estate after your death
• Withdrawals paid to the IRS to pay a levy on the 401k plan itself
• Withdrawals where your medical expenses exceed 7.5 per cent of your adjusted gross income

Understand the 401k withdrawal penalties

An ‘early 401k withdrawal’ means that you withdraw money from your 401k account before reaching the age of 59 1/2.

When you withdraw funds from your 401k you will often find that the withdrawal is taxable.  This means that not only do you have to report this as income on your federal income tax return, but you are also subject to an additional 10 per cent penalty.

CNN reports that ‘David Wray, president of the Profit Sharing/401(k) Council of America, said that people making hardship withdrawals could pay a penalty of up to 40 per cent, once state and federal taxes are added to the 10 per cent penalty.’

He said: “People take a very significant hit when they take a hardship withdrawal.”

As well as paying the 10 per cent penalty, understanding that there may be tax implications for withdrawing from your 401k plan is crucial.

Beth McHugh, vice president of market insights for Fidelity advises participants that the penalties for hardship are so high that they should brace their finances at tax time.

She said: “People should be prepared, because when it comes time to do their tax filing, that money is taxed as income.  They need to make sure they keep some of that money aside so they can use it to pay their taxes instead of spending it.”

At retirement, many people suddenly find themselves holding more money than they ever have before.  It may be tempting to splash your 401k pot on luxuries but the reality is that you have to work out how it can last you through your retirement.

And, you also have to work out what distributions you can take, where you should invest your money and how much you’ll need to live on.  It’s a tough job, and so here are three things you should do with your 401k plan when you retire.

Start planning early

Ted Benna, the creator of the first 401(k) plan says: “You want to start thinking about retirement six months to a year before you do it. There are economic preparations you need to do.”

Six months to a year before your retirement you should look at your portfolio and work out whether it is going to last you through your retirement.  401k plans will often make the most money in the last few years before retirement so be very careful if you want to retire early as this could limit some of the gains you make.  And, of course, you don’t want to run out of money and have to rejoin the work force at a later age.

Work out where your investments will go

When you retire, you also have to decide where your money should be invested. For example, if your 401k plan has mostly been invested in company stock you may want to consider pulling it out and investing in mutual funds instead.

The company overseeing your 401(k) plan will often encourage you to keep your money in-house. They will offer you investment options in an attempt to keep your cash and benefit from the management fees.

If the company offers a good range of investments and funds, excellent performance and low charges then it may well be worth staying put.  However, with lots of alternatives it is always worth shopping around to see if there is a better home for your money.

Get professional help

If you have a decent sum of your money in your 401k plan – many people have in excess of $500,000 – it may pay to seek professional advice.

Michelle Anderson, vice president of personal investment counselors with First Union Brokerage Services Inc, says: “Anyone with that net worth needs a full-rounded financial planner, to talk about insurance, taxes, the direction to go with retirement accounts.”

If you are newly retired you will have lots of decisions to make. A professional advisor can help you:

• Work out how to make your money last through your retirement
• Decide how you want to take your income distributions
• Advise you on possible strategies for investment
• Work out plans for your estate
• Draw up the necessary legal documents