10% penalty exception?

[frazzled]

Scenario:

A single taxpayer loses her job. She rolls over her 401K into an IRA. A month later she withdraws all funds and uses a portion of it to purchase a home (first-time). Could the portion ($10,000) used for the home purchase be excepted from the 10% penalty? I am having a hard time with this as the funds were originally from a 401k, which does not allow an exception.

THANKS for all input!

[Pacun]

Only IRAs don't pay 10% penalty.

[Achmid]

Maybe a grayish area-do your research? Do not take the deduction you lose it whether entitled or not!

[Gail in Virginia]

Bus as I understand this, she did not take a distribution from a 401(k). She rolled over her 401(k) money, then took a distribution from her IRA. And a distribution from an IRA can be used for first time home purchase without penalty. I agree, you should do the research, but I think that is what you have.

[TAXBILLY]

Gail is correct. There is no problem here.

taxbilly

[kcjenkins]

I agree, in fact, she did exactly what she should have done. By first rolling it into the IRA she made it available to use without penalty, although of course, it's still taxable.

[Cathy]

Scenario:

A single taxpayer loses her job. She rolls over her 401K into an IRA. A month later she withdraws all funds and uses a portion of it to purchase a home (first-time). Could the portion ($10,000) used for the home purchase be excepted from the 10% penalty? I am having a hard time with this as the funds were originally from a 401k, which does not allow an exception.

THANKS for all input!

Probably gonna regret this response as it will definitely show my age, but here goes:

I completely understand your being "frazzled" over this one. Years ago, I also had a hard time with the situation and researched until I was crosseyed but could not find where IRS disallowed anyone, even an employee, from making a withdrawal from their 401(k) to purchase a principal residence and immediately rolling it over to an IRA......THEN withdrawing the $10,000 from the IRA to bypass paying the 10% penalty on the $10,000 portion.....and I told several clients to "go for it" but to "just make sure the distribution is rolled over into an IRA first". I carefully reviewed the instructions, publications, etc..each year until IRS finally realized the "loophole" and issued a new rule that prevented a taxpayer from using the "residence" exception for the penalty for an IRA unless those same funds (rolled over from a 401k) had remained in the IRA for 12 months or so(don't remember the exact number of months)PRIOR to purchasing the residence.

Then, over the years, more rules and regs, etc....

Under current rules and regs., if an employee withdraws funds from his 401(k)to help purchase his/her "principal residence", it falls under the "Hardship Distribution" rule, and a rollover from an employee's 401(k)under the "Hardship Distribution" is not eligible for a roll-over, therefore, the 10% penalty would apply....no way around it.

To put it in simplier terms:

The key here is that your taxpayer is no longer classified as an "employee" under her 401(k) as she lost her job. Therefore, she was eligible to roll over her entire 401(k) into an IRA...thus able to withdraw up to $10,000 without the 10% penalty.

As long as the funds are eligible for and rolled over to an IRA then withdrawn....no penalty.

.....and there you have it..."The Simpler, Kinder, Gentler IRS" as it was once called some years back. I shuddered when I heard Obama in The State of The Union Address say we need a simplification of our tax codes.....every time they simplify things, it only gets worse!

O'kay....I have made myself sick to my stomach rehashing old codes vs. new codes, etc...so don't be surprised if this is my first AND last post of the season.

Take care,

Cathy

[frazzled]

Wow! Thanks for all the great responses!

Cathy, don't feel bad about your "seasoning". I lost my office old-timer (who had been doing taxes for 50 yrs) about 5 years ago. I miss him telling me about the history of tax changes. I always find it interesting. After being in the tax prep biz for about 13 yrs, I catch myself educating clients about the short term history of a credit or deduction!