Visitor I

401k loan/early distribution

I am in a situation where I have been offered a different job, which is great move for me. About a year ago, I took out a 401k loan for $33,000 of which I have an outstanding balance in the neighborhood of $28,000. This leaves me with a 401k balance of $122,000. I am going to take this newposition and currently do not have the funds to pay this loan off. I plan on taking a $30,000 distribution for a down payment on a new house in my new city (this is not up for debate). My question is should I increase my distribution by $28,000 to pay off the 401k loan or should I increase my distribution by approx. $15,000 to just pay the taxes and penalties on it and move on?

3 Comments
Catalyst V

401k loan/early distribution

Depending on the rules of your plan, when you leave your current job the balance of the current loan is due and payable in full immediately, or within 30 days after you leave the current job. That too is not up for debate.

If the loan balance is not paid in full within the time constraints of your plan and loan agreement, then the lender will withdraw the balance due from that 401(k) and they don't need your permission to do so. You aleady agreed for that to happen at the time you took out the loan. But there is a possible work-around that will avoid any penalties, depending on the retirement plan offered at your new job and the rules and requirements of that plan.

At the new job, roll over say, $80K from the old 401(k) to the new 401(k) you will establish with your new employer. Then take out a loan against the new 401(k) for the balance due on the existing loan, and use that money to pay off the existing loan. That way, there's no early withdrawal penalties or taxes assessed on any 401(k) funds used for this purpose.

You'll need to check the rules and requirements of your old plan first, to see how much of a grace period if any, you will have to pay the existing loan in full after leaving the old job. You'll also have to determine how fast you can complete the rollover to a new 401(k) (assuming your new employer offers a 401(k) plan) and what the borrowing rules and requirements will be for you on that new plan.

So if your balance on the existing loan is $28K and you can take out a new loan from your new 401(k) after completing the rollover and use that money to pay off the old loan, that would mean your payments on the new 28K loan would also be lower most likely, depending on the interest rate.

I would be very interested to know if this will work for you, thus avoiding paying taxes on 28K as well as the early withdrawal penalty. Most likely, if the loan is paid off with an early withdrawal of 28K,that amount would most likely raise your AGI enough to put you in a higher tax bracket for the 2018 tax year. So if you can utilize my method, you may be able to avoid the higher tax bracket, taxes in excess of 23% on the early withdrawal, and the 10% early withdrawal penalty.

Now for buying a house, if you are a first time home buyer you can withdraw a maximum of $10,000 from your retirement account penalty free for that. But do understand that it will NOT be tax free. You will still pay taxes on that early withdrawal. To avoid the penalty, you must use every dime of that early withdrawal as a down payment on  your first home, and you must close on the sale within 60 days of the withdrawal.

So if you take a $10,000 early withdrawal for a first time home purchase, make sure you have at least $2000 from other income sources that  you can utilize to pay taxes on that early withdrawal.

Finally, if you are married and your spouse has a 401(k), then your spouse can also withdraw a maximum of $10,000 from their 401(k) penalty free if your spouse has never owned a home before. That would give you a total of 20,000 to put down on your first house. But then you'd need to come up with about $4000 from other income sources to pay the taxes on both of your withdrawals. So keep that in mind also.

 

Visitor I

401k loan/early distribution

Neither me or my wife are first time homebuyers, so that’s not an option. I’m taking this new job which will bring a 35% raise. It’s just going to be tough at first. That’s why I’m willing to pay taxes and penalties on the 28k, just to increase my cash flow by $600/mo. I also need approximately $30k to avoid PMI insurance, hence the new withdrawal. Do I want to do this? No. But it’s the only way to get myself in a position to accept this position and afford two mortgages for a while if I have to.
Catalyst V

401k loan/early distribution

You may want to look at cost here since you're both not first time home buyers.

Is the 10% early withdrawal penalty along with the taxes you will pay on that withdrawal, cheaper than paying PMI for the two years or less it would take you to "aggressively* pay down the loan with the extra cash flow the new job will bring? Once you get the loan balance under 80% of the appraised value, the PMI goes away.

I would expect with a 35% raise combined with an early withdrawal which will add to your AGI that year, you'll be in a higher tax bracket too. So that may be something to consider.

What I've done in the past is put 10% down on a house which resulted in PMI. This was a 90K loan on a $100K house. After two years I'd paid the loan balance down to about $86K. So I paid $450 for an appraisal. It appraised two years after I purchased it, at about $115K. 80% of that appraised value was $92K. So with an outstanding loan balance of $86K I was quite easily under that 80% threshold and the bank dropped the PMI.