401k Withdrawal for First Time Home Purchase

[Patrick Michael]

Client took a distribution from his 401K for down payment on first home.  He is under 59 1/2.  He received a 1099 K for the disbursement coded "1", so I'm sure it wasn't a loan.  The mortgage broker told him he would not have to pay the 10% penalty but I believe that is just for distributions from IRA's and a quick google search did not say one way or another.

Can anyone give me a quick sanity check?

[Lee B]

According to The Tax Book, IRA - Yes, 401K - No

[jklcpa]

A 401(k) withdrawal for purchase of taxpayer's residence is one of the items listed that can be considered a hardship withdrawal. Perhaps this is what the mortgage broker and client had in mind.

See this page at IRS.gov for more information and that references the reg in the 3rd paragraph of question #2: (Reg. Section 1.401(k)-1(d)(3)(iii))
https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-hardship-distributions

and this page also:

https://www.irs.gov/retirement-plans/hardship-distributions-from-401k-plans

 

[BulldogTom]

This is one thing I wish the IRS would change.   It seems very inconsistent that you can take money from 1 retirement account penalty free for a first home purchase and not from another.   Rant over.

Tom
Modesto, CA

[jklcpa]

Exactly, Tom!   I included those pages that states that the hardship distribution is allowed and will be taxable, and that the allowable distribution may also include the taxes and penalties incurred as a result of the distribution! 

[Patrick Michael]

Thanks everyone.  Another case where if he had called first I would have had him take a loan instead.  Client is not going to be happy!

[Patrick Michael]

And it gets better.  Client now tells me he was told by the national brokerage firm that holds the 401K that they could avoid the penalty and repay the distribution under the CARES Act.  The problem is client never had COVID, was never quarantined, and did not suffer any any financial consequences from being unable to work.  He did put half of the distribution back into the 401K, using post tax funds, within 60 60 days.  The brokerage firm listed the deposit as "Rollover Deposit". 

Any chance the repayment can be used to reduce the taxable amount of the distribution?

[Pacun]

On another post, I have argued that almost everybody has been affected by Covid.  I put an example of my case.  I got a call that someone needed me to prepare a W7 for which I charge $60. DC government had closed all businesses that were non-essential and tax preparers are not considered essential in DC. So I couldn't make those $60 because the client went to MD where tax preparers are essential workers.  According to what I read, I could take out $100K from my 401k plan and pay no penalties. I could also put back 1/3 before filing my timely 2020 1040 return and pay no income taxes... provided I elected to pay taxes on the next three years.  Let's say that I didn't have that event, my wife collected unemployment because her hours were reduced for a month.  I also had a household member who didn't work because her restaurant was closed for three months.  Any of these three situations alone would qualify me to take out $100K from my 401k and pay 0 penalty. 

 

[Max W]

On 2/16/2021 at 12:17 PM, BulldogTom said:

This is one thing I wish the IRS would change.   It seems very inconsistent that you can take money from 1 retirement account penalty free for a first home purchase and not from another.   Rant over.

Tom
Modesto, CA

Isn't that what the "I" in IRS stand for  - Inconsistent.

All kidding aside, it is congress, not the IRS, that creates retirement plans and their requirements.  What is inexplicable is why there are 9 different plans.

[joanmcq]

Ah, Pacun, I have not been affected by Covid.  Have not gotten Covid, I've always worked from home remotely.  I see very few clients.  I was never shut down, because-remote!  My husband is my assistant.  Lost one (major) client, but it's because he's gotten WAY too complicated and decided to go to a bigger firm.  I agreed with him.  I've gotten 3 new clients already. 

[Lion EA]

I'm a lot like Joan, so as this whole pandemic lasted longer last tax season, I thought I'm not affected by Covid. But two clients died. Two great friends died, so I lost two days to attend outdoor funerals. And, a handful of my clients who were affected, furloughed mostly, asked to pay me in installments. I did receive the final installments from everyone by December. But my software renewal was August, my remote IT guy is on a monthly retainer, taxes/licenses/SOS report/etc. at various times during the year, so I ended up using personal funds for biz at a couple times last year. Now, I think I really AM affected by Covid. I'm also older than 59.5 but did take my RMD, couldn't skip it, needed it for biz and personal. Don't know if I'll spread it over three years, because our income won't drop because hubby started SS this January. But it's a case-by-case decision re qualifications, projected income, working with what each client did or didn't do during 2020 (most times without asking us), and we have to spend time explaining to every client who might qualify for various Covid-related benefits.

[joanmcq]

I haven’t had anyone die, and forgoed my RMD since I didn’t need it. Stock market is up. Have less expenses since I haven’t gone anywhere. I’m going stir-crazy, but financially I’m fine as are my clients as far as I can tell.

maybe I’m just weird.

[RitaB]

7 hours ago, joanmcq said:

I haven’t had anyone die, and forgoed my RMD since I didn’t need it. Stock market is up. Have less expenses since I haven’t gone anywhere. I’m going stir-crazy, but financially I’m fine as are my clients as far as I can tell.

maybe I’m just weird.

You’re not. Every one of my clients who applied for PPP loans had MORE revenue in 2020. I had more revenue in 2020. I actually got Covid in November 2020. Never missed a day of work, just told people not to come in the office. No financial hardship for me, no applying for assistance that wasn’t intended for me. Kinda mad at the windfall some received. Happy to help those whose businesses and livelihoods were destroyed, and I feel so badly for them, but I don’t know any of them.  It have felt sad and frustrated but I am thankful. 
 

[Lion EA]

I just went through my client list.

7% work for the aircraft industry, so all were furloughed &/or salaries reduced to this day

8% work in production of some sort that involves group work, such as theater, and didn't work from mid-March to this day (one runs a March job fair for performers/tech to meet with summer theater casting directors and had to return all her 2020 income but still had some nonrefundable deposits and other expenses already paid when her March 2020 event was canceled a couple days prior)

7% work in travel or hospitality with extreme drops in income (for one newish travel agent, $0 income in 2020)

7% work in the health care field, so a mix of "no change" and drastic change (a hospital engineer kept his salary for more hours; an ICU nurse kept her salary for more hours; a nurse in a doctor's office was reduced to half time; a nurse running group sessions at a psychiatric hospital was laid off entirely)

20% work in retail or personal services that require face-to-face, such as hairdresser, violin teacher, and other tutors; all were without work for some time; some were allowed to return to half time eventually; some were able to pivot to virtual with some new expenses

7% are teachers who kept their salaries but had more nondeductible expenses to teach from home as well as school

5% were strongly urged to retire or they would be furloughed (in some cases that resulted in a high income year for 2020 followed by a very low 2021; in others, 2020 income was lower, too)

3% died (I don't know their causes of death)

I'm sure I'll find out even more Covid consequences for my clients as I prepare their returns and hear their stories. My clients are in 13 states, with a heavy concentration in CT. I don't know how CT compares to other states, but we must have a lot of the virus (or, maybe just a lot of old people) because CT just opened vaccinations to 65 and older 11 February. Most of CT is still "red"; although, my tiny town of Weston just dropped to "orange." Our tiny school district has 71 students/staff isolated/quarantined. State-wide, 63 people have the new UK variant. This is going to last a while.