January 21, 2009

Taxation Committee
Federal Issues Committee

(The following is for study only and has NOT been approved by the Board of Directors.)

Issue:
At the October 2008 C.A.R. Business meetings it was requested that information be presented on the feasibility of accessing 401(k) accounts to help homeowners pay for their troubled mortgages.

Action:
Action is not required at this time

Status/Summary:
As the housing market has continued to face a tough decline, there has been a rise in homeowners finding themselves struggling to pay their mortgages. These troubled mortgages are leading to an increase in loan modifications, foreclosures, and attempts to help people access cash to help save their homes. One option mentioned is allowing homeowners to withdrawal from their 401(k), without penalty, to help pay their troubled mortgage.

The homeowner would still have to pay taxes on any withdrawal, but would not be penalized for withdrawing money prior to the eligible age, which is currently 59.5 years of age. The issue was brought up during the Presidential campaigns, but not specifically for use by homeowners.

If there is to be a change, there are some questions that would need to be addressed. First, what is the limit that one would be allowed to withdraw? Previous variations on this concept were between 10-15% of the total amount in the 401(k) and current exceptions allow for up to 50%, capped at $50,000. Second, what would the limitations be on spending the withdrawn money? Would it have to go to a saving a home or could anybody use it for whatever purpose they want, thereby still allowing a struggling homeowner to use the money on their troubled mortgage. Does this need to be a new regulation or can it just be an expansion of the current exemptions.

While this issue was brought up towards the end of the Presidential campaign and supported by President Obama, there has yet been any indication that such legislation would be brought forth in Congress or that the President would throw his weight behind the idea.

The current market conditions should also be considered when contemplating withdrawing money from a 401(k). Most people have taken substantial losses to their accounts and if the money is withdrawn now, those losses will be permanent and never have a chance to recover when the economy turns around. This can lead to substantially less money available for retirement and could force people to either have to work much later in age or present them with economic hardships upon retirement.

The 2008 Bank of America Retirement Savings Survey found that 18% of their respondents had withdrawn from their retirement accounts prematurely this year due to the current financial situation. Of those 18%, 25% had withdrawn to pay credit card debt, 22% had withdrawn to make mortgage payments, and 22% had withdrawn due to a recent job loss. Therefore, in 2008 the survey found that less than 4% of respondents had withdrawn funds from their retirement accounts prematurely in order to help pay for their mortgages.

Background:
The 401(k) plan was created in 1980 as a way to assist people in saving for retirement. The government was looking for new ways to encourage retirement savings so that individuals would not rely solely on the government to assist them in retirement. 401(k) plans are created through an employer and traditionally the employer matches contributions, to an extent, as an employee incentive. Money put into a 401(k) is tax deferred until withdrawn.

Congress made strict regulations concerning 401(k) funds and their withdrawal. Since they are treated with special tax deferment, money cannot be withdrawn until the age of 59.5 years of age without suffering a penalty on top of the tax consequences. The intention of these penalties was to ensure that retirement savings were not raided during rough patches and that the special tax benefits were not abused. Currently the penalty is an additional 10% tax on top of paying taxes on the amount withdrawn.

Currently there are exceptions that allow money to be withdrawn from a 401(k) without penalty, but taxes are still paid. These exceptions include suffering a disability, sky-rocketing health insurance premiums from loss of a job, sending a child to college, and also for first-time homebuyers. Under the 1997 Taxpayer Relief Act, if you are a first-time homebuyer (or haven’t purchased a home in at least two years), you can withdraw up to $10,000 penalty free, once in your lifetime, from your IRA for a purchase of a new home. Under a 401(k) plan you can borrow money from your 401K for a downpayment on a house, providing the plan has a loan provision and you agree to pay back the money in accordance with the 401(k)'s rules. This is capped at 50% of the available funds and not to exceed $50,000.

Pro:
This would give troubled homeowners another option as they try to find ways to help save their troubled mortgages in these tough times. It would allow them another asset to consider partial liquidation of in order to save their home.

Con:
Congress has always been very hesitant to allow people early withdrawal from their retirement savings account as they were created with a clear intent and special tax provisions. Additionally, there would be a risk that a troubled homeowner could liquidate their 401(k) account and still lose their home, resulting in twice the devastation.

Impact on REALTORS®:
There would be a small, if any, impact on REALTORS® if the 401(k) rules were changed. REALTORS® would be able to access the funds just as anybody else. The only area where this could impact REALTORS® would be in a family uses the 401(k) money to erase any negative equity they have in the house, thereby either allowing them to sell the house or to refinance the house into a more manageable loan.

NAR Policy:
Currently NAR does not have policy on this issue.

C.A.R. Policy:
Currently C.A.R. does not have policy on this issue.