How to Avoid a Mortgage Foreclosure With a 401k Hardship Withdrawal

401(k) plans are retirement plans within the United States that allow employees to save money for when they reach retirement age. Employees (with some employers also contributing funds) have income taken out of their wages tax deferred and put into a 401(k) fund. When the employee reaches retirement age, she can withdraw the funds to use for retirement and pay income taxes at that time. Withdrawals taken before the employee reaches age 59 1/2 are generally hit with a 10-percent penalty on top of the income tax. But if foreclosure on the employee's home is imminent, the IRS might allow a penalty-free withdrawal from a 401(k) plan. Or the employee might be able to simply borrow from the plan, under certain circumstances, in order to bring the mortgage current.

Instructions

1. Consider taking a loan against your 401(k) if you still are an employee at the company through which you funded the 401(k) plan. The loan must be repaid over a length of time specified by the company, and you may be required to repay the loan in full if you leave your job with that employer. Check with your company's plan administrator to learn the specific details of taking a loan from your 401(k) plan.

2. Contact your company 401(k) administrator and ask if hardship withdrawals are allowed. Employers are not required by law to allow hardship withdrawals, so you may not be able to withdraw from your 401(k) fund. You will need to contact the person within your company who oversees the 401(k) plan to ask if hardship withdrawals are allowed by the company. If you are not sure who this is, check with your finance or human resources department and ask them who administers the 401(k) plan.

3. Understand the drawbacks of withdrawals and decide if a withdrawal is the best decision. Even if your company allows hardship withdrawals, there are drawbacks to taking one to avoid mortgage foreclosure. Mainly: withdrawals are taxed as ordinary income. Also, you may need to provide your company with proof of your need for a hardship withdrawal--which means disclosing to the company the reason for your mortgage difficulties. Keep in mind that, in addition to averting a foreclosure, the IRS generally allows penalty-free withdrawals in cases of total disability or to pay a high medical bills, so if these are the reasons for your mortgage difficulties, you might have a stronger case to make for averting the 10 percent withdrawal penalty. Keep in mind, too, that one may have to prove that they have exhausted most of their other assets before they can take a penalty-free withdrawal from a 401(k) to cover an emergency.

4. Make the withdrawal. To make a hardship withdrawal, you will need to contact your 401(k) plan's administrator and fill out the necessary paperwork. Paperwork varies from company to company, and it may take up to 45 days to get the money from your withdrawal.

5. Account for taxes. You will owe ordinary income taxes, and you may owe an additional 10-percent penalty on the money you withdraw. Ask your plan administrator to have money set aside for taxes and the penalty when you make the withdrawal. For example, if you need to make a $10,000 hardship withdrawal and you are in a 15 percent income tax bracket, you will owe $1,500 in taxes plus a $1,000 penalty. Have the plan administrator take out taxes when you make the withdrawal so you do not owe taxes at the end of the year.

Tips & Warnings

• Hardship withdrawals from a 401(k) should be a last resort. Consider consulting a financial planner before you withdraw from your 401(k).

Resources

• CBS; 401(k) Withdrawals for Mortgages--Bad Idea; Ray Martin; March 13, 2008
• Bankrate.com: 401(k) Hardship Withdrawals
• IRS: Hardship Withdrawal FAQs