Can Money in Your 401(k) Be a Foreclosure Escape Hatch?

Daily Herald (Arlington Heights, IL), October 14, 2011 | Go to article overview

Can Money in Your 401(k) Be a Foreclosure Escape Hatch?


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

The Obama administration has been exploring options -- including a new refinancing program expected later this month -- but 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.

The change 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 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. However 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 percent of the current amount of funds in the retirement account.

Owners would still be subject to income taxes on the amounts withdrawn, but would escape the penalty.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 on the bill overall, 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. …

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