I have a 401K from a previous employer and I am not looking to roll it over. I want to take the cash now with the 30% deductions (10% withdrawal penalty, 20% Fed Tax) because I looking to use it as a down payment for a home. I am looking to purchase this home Dec 07 or Jan 08.

My question is... would it be beneficial to make this 401K transaction at the end of 07 and pay taxes on it in 08? OR should I wait until Jan 08, then pay taxes on it in 09 hoping that my tax break as a homeowner will offset the amount?

Help!

TwinSpin23:

My first piece of advice: DO NOT USE THE 401K MONEY FOR A HOUSE DOWN PAYMENT! The 401K is your retirement fund, not your housing fund.

If you insist, then roll the money over into a rollover IRA (custodian-to-custodian transfer), THEN you can withdraw up to $10,000 for a house and NOT pay the 10% Early Withdrawal Penalty IF you meet the criteria of being a first-time home buyer.

As for buying the home, DEFINITELY WAIT until Jan 08 before closing on the house. The reason is simple: in order to itemize, you must exceed the rather large standard deduction of $10,600. You will do this easily in 2008, and you will have the added benefit of being able to deduct points and loan origination fees you paid in toto in 2008. If you buy in 2007, those points and loan origination fees will have to be spread out over the life of the mortgage, because you will not be able to itemize in 2007 due to the large standard deduction.

Contact me at the email address below if you have further questions.

First there seems to be a misconception about the tax liability of 401K withdrawals. The 20% is a WITHHELD amount not what you have to pay. Just like taxes are withheld from your paycheck, 20% is withheld from your 401K withdrawal. The amount of the withdrawal is then added to your taxable income for the year and used to determine the amount of total tax you have to pay. So if your tax bracket is higher than 20% you may pay more.

I agree with the advice ATE gave you. If you can qualify as a first time buyer, you can use that to forego the penalty.