401K withdrawal for primary home purchase

[mircpa]

Hello friends

I know if 401K money is used to buy primary residence 10% early withdrawal penalty is waived. How should I make tax software knows about this. Any body knows how to work around. By the way client received 1099-R with distribution code 1.

thanks

[Jack from Ohio]

Form 5329

[ILLMAS]

A couple of years ago I filed a form (don't remember which one) for a client that took out money from his 401K to buy his first home, IRS disallowed it because the 401K was not an IRA. This happened in 2005 or 2006.

[BulldogTom]

MAS is correct. The penalty waiver is only for IRA's, not 401K's. Your client did the wrong thing. He should have taken a loan from the 401K rather than a distribution. Alternatively, he could have done a trustee to trustee transfer from the 401K (if the plan allowed early roll overs) to an IRA and then taken the distribution. I have seen this before and it really is a shock when the client learns they did it wrong and have to pay the tax and penalty. A lot of times, they don't even realize that even though the penalty is waived, the distribution is still taxable.

Tom

Hollister, CA

[Lion EA]

IRAs only. Maybe your client now has learned to call you first.

[Janitor Bob]

Agreed....waiver is for IRA only...not 401k...does not seem fair, but that's the way it is.

[Mr. Pencil]

Even for an IRA the penalty applies on lifetime amounts over $10,000 or anyone who has owned a home in the last two years. Normally one can't withdraw anything from a 401(k) without leaving the job, but purchase of a home is allowed under "hardship" rules.

[mcb39]

Even for an IRA the penalty applies on lifetime amounts over $10,000 or anyone who has owned a home in the last two years. Normally one can't withdraw anything from a 401(k) without leaving the job, but purchase of a home is allowed under "hardship" rules.

That is true, but the last I heard it still does not relieve you from the tax AND penalty. Hardship rules do not relieve the penalty.

[Cathy]

That is true, but the last I heard it still does not relieve you from the tax AND penalty. Hardship rules do not relieve the penalty.

You are correct. "Hardship" rules involve 401(K) plans and IF an employer allows the purchase of a home to qualify

under their "Hardship" rules, the taxpayer is responsible for a 10% penalty and the income taxes on the amount of the

distribution. There is no $10,000 limit on the amount of the distribution, neither is there a wavier of the 10% penalty

on the first $10,000 in this case as the distribution is from a 401(K), not an IRA. (Some employers might have limits, although I had a client who withdrew his entire 401(K)a few years back.)

Just had two clients who were very fortunate. She separated from her job in 2013 then transferred her 401(K) to an IRA. The fact that she no longer worked for her 401(K) employer is the reason she was able to roll-over her entire 401(K).

She and her spouse shortly after decided to build a new home as they were tired of paying rent for about 5 years. The first $10,000.00 of her distribution qualifies her for the wavier of the 10% penalty as it was a distribution from her IRA. The clients were still disappointed they owe both Federal and State taxes, however, they lucked up with a $1,000 savings on the penalty. They swear they will call me first before they take such actions.

Take care,

Cathy

[kcjenkins]

They swear they will call me first before they take such actions.

Yeah, that will last about 6 months, usually!

[BulldogTom]

Most taxpayers hear that they can get their money out of a plan under the "hardship rules" and think that applies to the tax law as well. I don't know how we got to the place where people don't know the difference between advice given by a 401K plan administrator about a plan and tax advice. It costs them so much money for the things they do under the advice of the wrong expert.

Tom

Hollister, CA

[kcjenkins]

THAT IS SO VERY TRUE. And it can be a royal pain to have to waste time re-educating the client, because they got the original bad advice from "an expert".

[mcb39]

Most taxpayers hear that they can get their money out of a plan under the "hardship rules" and think that applies to the tax law as well. I don't know how we got to the place where people don't know the difference between advice given by a 401K plan administrator about a plan and tax advice. It costs them so much money for the things they do under the advice of the wrong expert.

Tom

Hollister, CA

Several years ago, I had a single male who did just that. No withholding whatsoever. I didn't know him that well then, but having to impart the bad news was one of the worst tasks I ever had as a tax professional. I remember having to talk to the plan administrator (who, of course) had explained all of the tax repercussions very clearly. I truly feared for the young man. He was in so much despair and shock. He had no money, but he did have a job. He made payments to the IRS for a number of years. I can happily report that he is now married, much more mature and knowledgeable and one of my most faithful and supportive clients.

[Cathy]

Marilyn,

I had a newly married couple years ago in the same situation, and I found myself being their "Mom" and hugged and consoled them because they owed $116.00 on their 1040. I had to fight myself really hard not to offer to pay their balance...not because I didn't advise them properly on how to fill out their W-4's because they were a first year client. It was just that the situation was so brutally painful for them.

Fast forward to present day....same couple's income has grown by 15 times what it was back then, but you guessed it, they never have owed since that first year and they always call me before they make any financial decisions that will affect their income taxes. The maturity as you spoke of has definitely increased by at least 15 times as well.

[pikester1967]

I'm sitting here working on an amendment regarding the same matter, but a medical expense exception. Found this in RIA Checkpoint. Now I'm looking for guidance as the wording indicates an exception.

¶ 4344. Penalty for premature distributions—Form 5329.

Early withdrawals from a qualified retirement plan, SIMPLE plan, or IRA result in an additional tax (reported on Form 5329 ) equal to 10% of the amounts withdrawn that are includible in gross income. (Code Sec. 72(t)(1), as of 10/31/12) The additional tax applies to all withdrawals unless specifically excepted. Exceptions include distributions (i) made on or after age 591/2 ; (ii) made to a beneficiary or estate on or after death; (iii) attributable to disability; (iv) from a qualified plan after an employee's separation from service in or after the year in which he attains age 55 (this rule does not apply to IRAs); (v) not in excess of the amount allowable as a medical expense deduction for the year, whether or not the distributee itemizes; (vi) that are part of a series of substantially equal periodic (annual or more frequent) payments (made after separation from service if from a qualified plan) for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of the employee and his beneficiary; (vii) from an IRA not exceeding amounts paid for medical insurance by IRA owners who have received unemployment compensation for at least 12 weeks (or could have except for being self-employed); (viii) from an IRA for qualified higher education expenses; (ix) from an IRA for qualified “first-home” purchases, subject to $10,000 lifetime cap; (x) from a qualified plan to an alternate payee under a qualified domestic relations order (QDRO ¶ 4320; this rule does not apply to IRAs); (xi) made on account of an IRS tax levy, and (xii) from a phased or composite retirement annuity under the Federal Phased Retirement Program. (Code Sec. 72(t)(2), as of 10/31/12, Code Sec. 72(t)(3), as of 10/31/12) FTC ¶ H-11100 et seq.; USTR ¶ 724.22; Tax Desk ¶ 145,501

[kcjenkins]

OK, you quoted the list of exceptions, so what is your question? Exception 5, "not in excess of the amount allowable as a medical expense deduction for the year, whether or not the distributee itemizes" means just what it says. ALL of it is subject to tax, of course. The only part the exception protects is the penalty for early withdrawal. And that is not as inclusive as clients often assume The way I calculate it is by doing a Sch A even if the client is not itemizing, to determine how much of his medical costs would be DEDUCTIBLE on the A if he did itemize. That amount then goes on the 5329 Line 2 with Code 05.

Keep the Sch A in your notes, even if not used in the return, to back up your amount you excluded on the 5329.

[Jack from Ohio]

Agree with KC.

[pikester1967]

My apologies the question was somewhat incomplete.

Client withdrew from a 401k, not from an IRA as previously discussed by other members. When I'm looking at the code it states "Early withdrawals from a qualified retirement plan, SIMPLE plan, or IRA result in an additional tax."

Question being, in others piers experience are we noticing 401k retirement not being considered a "qualified retirement plan" for early withdrawals penalties and exceptions?

[jklcpa]

A 401k plan is definitely a qualified plan. I don't know why withdrawals from them would be excepted from being able to avoid the early w/d penalty and haven't personally had the issue your peers are noticing.

[kcjenkins]

A qualified plan is an employer-sponsored retirement plan that qualifies for special tax treatment under Section 401(a) of the Internal Revenue Code.

(c ) Qualified retirement plan
For purposes of this section, the term “qualified retirement plan” means—
(1) a plan described in section 401 (a) which includes a trust exempt from tax under section 501 (a),
(2) an annuity plan described in section 403 (a),
(3) an annuity contract described in section 403 (b ),
(4) an individual retirement account described in section 408 (a), or
(5) an individual retirement annuity described in section 408 (b ).

There are many different types of qualified plans, but they all fall into two categories. A defined benefit plan (e.g., a traditional pension plan) is generally funded solely by employer contributions and provides you with a specified level of retirement benefits. A defined contribution plan (e.g., a profit-sharing or 401(k) plan) is funded by employer and/or employee contributions. The benefits you receive from the plan depend on investment performance.

[jshtax]

If still employed take a loan if old 401k roll over to ira then distribute.

[Pacun]

Loans needs to be repaid while distributions you only pay the tax and maybe penalty on the first 10k.

You cannot take a loan and roll it over. I can take the distribution, within 60 days you can roll it over and then maybe you can take a distribution from the IRA.

[jklcpa]

There is a danger of taking a loan because if employment ends, it turns into a distribution that could be subject to a penalty.

[David1980]

My apologies the question was somewhat incomplete.

Client withdrew from a 401k, not from an IRA as previously discussed by other members. When I'm looking at the code it states "Early withdrawals from a qualified retirement plan, SIMPLE plan, or IRA result in an additional tax."

Question being, in others piers experience are we noticing 401k retirement not being considered a "qualified retirement plan" for early withdrawals penalties and exceptions?

The exception for a first time homebuyer states "individual retirement plan" not "a qualified retirement plan".

http://www.law.cornell.edu/uscode/text/26/72

(F) Distributions from certain plans for first home purchases

Distributions to an individual from an individual retirement plan which are qualified first-time homebuyer distributions (as defined in paragraph (8)). Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), ©, (D), or (E) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B ).

Edited February 11, 2014 by kcjenkins
to remove the smilie

[jklcpa]

David1980, if you go back and look at pikester's first post, #15 in this topic at 4:54pm, he's asking about withdrawals for medical expenses and not a home purchase.