IRA Early Withdrawal Exception

[JJStephens]

Client got ex'es 401k in the divorce. She is converting it to an IRA in order to withdraw funds for a down payment on a house (as you know, up to $10k is not subject to the 10% early withdrawal penalty for qualifying first time home buyers).

Here's where things get interesting. She has to close within two weeks but the investment broker says it will take longer than that to transfer ownership of the 401k to her, convert it to an IRA and then do the withdrawal. The mortgage company says they will write the loan with a smaller initial down payment (but charge PMI) and then accept the balance when the IRA withdrawal comes through (and eliminate the PMI).

Pub 590 says that in order to qualify for the early withdrawal penalty exception the money has to be used for 'acquisition costs' within 120 days of the withdrawal. It also defines the acquisition date (contract date for purchases; occupancy date for builds/rebuilds)--but does not indicate what the significance of that date is. In this case, the funds would be given to the mortgage company immediately upon receipt.

What I'm unsure of is whether the withdrawn funds can be applied AFTER the closing date and still qualify for the penalty exception. Any thoughts (other than delaying the close, which the mortgage broker is apparently not willing to do)?

[michaelmars]

YEAH, transfer it to a different broker then do what is planned. this should not take 2 weeks. another option is to postpone the closing but make sure its within the time frame for the house purchase credit if thats a factor.

you can always postpone a closing, just have the client or her attorney get sick!

[jainen]

>>the mortgage broker is apparently not willing to do<<

There's more mortgage brokers around these days than buyers with a solid down payment.

[joanmcq]

If the 401K is transferred as a QDRO, there is no penalty for her either, is there? but if she transferrs it to an IRA she doesn't qualify for the QDRO penalty exemption.

[jasdlm]

Joan is right. Why roll to an IRA as a result of the QDRO? Then she only qualifies for the $10,000 penalty free. If she takes the distribution directly from the 401(k) pursuant to the QDRO, she can take the entire amount penalty-free under the divorce exception (Does NOT apply to IRAs).

[mcb39]

BUT, won't she still have to pay income tax on the distribution? I have a similar situation coming up and we have to do some planning. So far, the plan was to roll into an IRA for my client in order to avoid tax as well as penalty.

[Lion EA]

If you're going to keep it in a retirement plan, you will avoid both penalty and income tax. But, if you need it for home buying, for instance, taking it immediately as it moves via QDRO from ex-spouse's name to yours will allow the divorce exception to penalty on that partial or total distribution. Once you roll it over into an IRA, the IRA rules rule when you take a distribution.

[mcb39]

I was referring to Income Tax on the $10,000 she is withdrawing for a downpayment on a home. However, in reading back over the posts, I feel that the preparer is aware of that liability and is only wishing to avoid a penalty. I just hope the attorney (or someone) is smart enough to have tax withheld from the distribution, as opposed to the attorney that my client HAD!