Proposal would allow homeowners facing foreclosure to tap into 401(k) without usual tax penalties

Homeowners could get 401(k) tax break

WASHINGTON — With hundreds of thousands of homeowners facing foreclosure and an estimated 2 million or more in the wings, are there any financial tools available to distressed borrowers that haven't been tried yet? Is there a way to help owners that won't rack up huge federal expenditures and add to the deficit?

A concept has surfaced on Capitol Hill that might offer modest help with no revenue cost to the government: Amend the tax code to allow homeowners who have 401(k) retirement plans to pull out money to save their houses from foreclosure without the usual tax penalties.

Under current rules, anyone making what's known as a "hardship" early withdrawal of funds from their 401(k) must pay the IRS a 10 percent penalty on top of ordinary income taxes. A new bill introduced Oct. 5 would waive the penalty if the purpose of the distribution is to make loan payments to avoid loss of a primary home to foreclosure.

Co-authored by Sen. Johnny Isakson and Rep. Tom Graves, both Republicans from Georgia, the bill would allow owners to pull out up to $50,000. The money could be used in a lump sum to pay down the delinquent mortgage balance or to fill shortfalls caused by reductions of household income. It could also be used as part of loan modification agreements with lenders designed to avert a foreclosure. The money would need to be spent within 120 days of receipt and could not exceed 50 percent of the amount of funds in the account.

Owners still would be subject to income taxes on the amounts withdrawn, but would escape the penalty. Though neither of the co-sponsors claims the bill would actually raise revenues — they simply say it won't cost the government anything — some pension program experts say it might. Edward Ferrigno, vice president for Washington affairs at the Plan Sponsor Council of America, a group that represents employers who offer workers 401(k) accounts, said that by triggering taxable distributions from otherwise untouched, tax-deferred plans, the bill "should generate revenues." Ferrigno declined to comment specifically on the bill, pending further review of its provisions.

Titled the HOME Act, the proposal sheds light on the potential foreclosure-avoidance resources — and the drawbacks — connected with tapping employee pension accounts. Many, but not all, 401(k) plans allow for loans to participants. Retirement advisers generally recommend taking a loan from a plan because the money withdrawn is not taxed or penalized. Borrowers are required to pay interest on the loan, but in effect they are paying it to themselves to offset the earnings forgone on the balances taken out.

Many 401(k) plans also provide for "hardship" withdrawals. However, these come with much stricter rules, fewer eligible uses, plus the tax penalties.

Kenneth R. Harney can be reached at kenharney@earthlink.net.

Proposal would allow homeowners facing foreclosure to tap into 401(k) without usual tax penalties 10/15/11 [Last modified: Saturday, October 15, 2011 11:39am]

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