BAP Blog Legislation to remove penalty for using a 401(k) to avoid foreclosure

The proposed legislation would 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. Their are hundreds of thousands of homeowners facing imminent foreclosure and estimates of 2 million or more in the wings. The Obama administration has been exploring options which includes a new refinancing program expected this unveiled this month. But new a concept has surfaced on Capitol Hill that might offer modest help with no revenue cost to the government. It would mean amending 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. It would work like this: 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% penalty on top of ordinary income taxes. A 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. 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. No matter how the money is used to resolve the mortgage delinquency, it would need to be spent within 120 days of receipt and could not exceed 50% of the funds in the retirement account. Home owners would still be subject to income taxes on the amounts they withdraw. Titled the HOME Act, short for Hardship Outlays to protect Mortgagee Equity Act, the proposal sheds light on the potential foreclosure-avoidance resources and its drawbacks that are connected with tapping employee retirement accounts. Most, but not all, 401(k) plans allow loans to participants, including for housing-related purposes. Retirement advisors generally recommend taking a loan from a plan because the money withdrawn is not taxed or penalized.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 any earnings lost on the balances taken out.