Hardship distribution for Purpose of Principal Residence

[Guest tonjer]

We have an employee who is requesting a hardship distribution to build a house. What kind of documentation do we need?

[Guest cherryred]

We have a similar situation....any comments on whether it is okay to permit a hardship distribution for construction of a primary residence?

[Guest Brooke]

Yes, I think it would be permissable to allow a hardship withdrawal to build/purchase a primary residence. Here's what I would require:

If the builder is carrying the construction loan, the builder will require the purchaser to obtain pre-approval from a mortgage company. But the purchaser may not be out an money until he actually buys the house at closing. In this case, I would treat it like any other primary home purchase. I probably would not process the hardship until closing.

If the builder is not carrying the construction loan (i.e. your employee is obtaining a construction loan and will begin making mortgage payments when construction is started), I would probably process the hardship once the employee obtains the construction loan. To verify the amount of the hardship request, I would compare the purchase price land the construction loan approval amount. Any gap would be a down payment required by the purchaser.

Hope this helps - By all means, please consult your ERISA attorney for a definitive answer.

[GBurns]

tonjer,

Wouldn't a plan loan be better, provided of course, that this plan allows loans? If you do not have a loan provision, could one be put in place in time to help this employee? I have always thought that this was a better way to access money for most employees.

[R. Butler]

If he could get a loan, technically he couldn't take the hardship.

[JanetM]

Many of my participants take the hardship after taking the minimum loan amount. This is usually because the institute financing the mortgage frowns on large 401(k) loans.

[GBurns]

Considering the cost differences between a hardship withdrawal and a plan loan, it seems that it would be very much worth their while for your employees to seek another source for the mortgages. In todays market mortgages are competitive motgages seem to be available all over the place.

What is so special about this mortgage source that makes your employees want to pay extra and put up with such restrictions?

[JanetM]

Am confused by your answer. But I think you mean why would participant prefer mortgage over plan loan.

Most of our employees are your 25K a year earners. The hardship is for down payment. Yes the cost of taking a hardship is tax and penalty - but if they incur large plan loan they may not qualify for mortgage. By taking the minimum loan - they are eligible for hardship as no additional loans can be made. Mortgage loan interest is tax deductible to participant - plan loan interest is not.

I know a plan can make a "mortgage" type loan - but our does not. In all my years in this business - even as TPA for CPA firm - I never once saw plan allow a loan for more than five years.

[R. Butler]

By taking the minimum loan - they are eligible for hardship as no additional loans can be made

Technically they still wouldn't be able for the hardship if they can get the money from other assets or commercial sources (such as a mortgage loan).

[GBurns]

First, if as you say, they are taking only minimum loans, doesn't that mean that they still have loan amounts available thereby disqualifying them from hardship withdrawals? In other words minimum loan means that they are not eligible for hardship w/d.

Second, I meant that the participant should prefer plan loan over hardship withdrawal.

Third, Have they really worked out the tax effect to their tax return? I bet that most of these $25K earners will (with the mortgage interest) now have more deductions etc than they can use (deduct) and so the tax and penalty of the hardship w/d will be a greater burden.

Fourth, Why does the plan loan have any effect on mortgage qualification? As I pointed out before, they most likely need to get a different mortgage source, this one seems very questionable.

Last, To whom is the 401(k) plan loan payable????????

[JanetM]

At the risk of getting into a long and heated discussion I will address your points.

You said: First, if as you say, they are taking only minimum loans, doesn't that mean that they still have loan amounts available thereby disqualifying them from hardship withdrawals? In other words minimum loan means that they are not eligible for hardship w/d.

I say - No. Taking the minumum does not mean you still have funds available. Example - our Plan says you can only take one loan in 12 month period. Participant borrows funds in January, decides to buy house in August. Since no loan is allowed at his time - regardless of amount borrowed and amount available - how could you deny hardship?

You said: Second, I meant that the participant should prefer plan loan over hardship withdrawal.

I say: What if the loan creates financial hardship - in this case person is buying house - so in addition to monthly mortgage they have loan payment.

You said: Third, Have they really worked out the tax effect to their tax return? I bet that most of these $25K earners will (with the mortgage interest) now have more deductions etc than they can use (deduct) and so the tax and penalty of the hardship w/d will be a greater burden.

I say: Not necessarily - as you point out - with the mortgage deduction their tax rate will be low - meaning the tax on hardship will be low. As a one time event, grossed up for taxes, this hardship can allow lower income individuals to purchase a home - and still afford to make the payments.

You said: Fourth, Why does the plan loan have any effect on mortgage qualification? As I pointed out before, they most likely need to get a different mortgage source, this one seems very questionable.

I say: Most lenders - regardless of what type of institution - require a certain amount of disposable income. If participant takes loan from plan

that debt, seen the same as credit card or auto payment. Reduces the amount the participant can pay for mortgage. If the total payments mandated to be paid each month is over a certain percentage of participants income - no institution will make the mortgage loan. (this of course ignores the exsistance of subprime vultures)

You said: Last, To whom is the 401(k) plan loan payable????????

I say: I don't understand your question - the loan is payable back to participants account.

As you are so quick to tell posters they haven't thought through their responses maybe I make a "GBurns comment" and say you should stick to cafeteria plans. But I won't because I am one who believes if you have nothing nice to say, shut your mouth.

[Guest TAG]

Well said Janet M.

Benefitslink is a terrific resource that allows those of us in the business to share thoughts, brainstorm together and ask questions. Lately, this site has been turning into a chat room where certain people are rude, unprofessional and intentionally disrupting the real intent of the post. We are all here to help each other - are we not?

TAG

[GBurns]

TAG,

You are quite correct and I thank you for posting your observation. If you look back at my posts you will see that on a number of times I have asked readers and the Moderator for such comments, but as you will see almost none were forthcoming, leaving the impression that there was absolutely nothing rude or unprofessional going on.

[GBurns]

JanetM,

Instead of responding to all the issues in your post, which would only be my opinion, I will refrain, hoping that others will address both your post and mine, however there are a few items that I will ask you to reconsider:

I say: What if the loan creates financial hardship - in this case person is buying house - so in addition to monthly mortgage they have loan payment.

GB: From a financial planning perspective, this person seems marginally solvent and should consider whether or not they are purchasing beyond their means and their risk of default in the near future wnd the consequences. In addition IMHO the purpose of hardship w/d is to correct current situations, however, in your posted scenarion, the hardship is a future ocurrence (after the purchase) and therefore not currently a hardship. Does the plan allow hardship w/d for a possible future ocurrence (possible because it depends on the closing taking place)?

*********************

"If participant takes loan from plan that debt, seen the same as credit card or auto payment."

GB: I do not think that this is correct. Plan loans should not be taken into consideration. I know that none of the mortgages that I have seen take this into consideration not only because it does not appear on a credit report but also because as you posted "the loan is payable back to participants account". Maybe we have a mortgage person as a reader who can give a factual opinion on the industry practice.

**********************************

Re your last paragraph.

I leave that to the posters who read this Forum to decide who reads the posts before responding, whether the posts are factual, and what or who is rude.

[Guest TAG]

GBurns - I appreciate your comment. Unfortunately I think you missed the point...perhaps no one responds because they do not want to argue with you or be insulted.

TAG

[GBurns]

TAG,

Good point, but while I have not looked it up, I can only remember 1 "victim" and he is quite capable of defending himself. Thanks.

[JanetM]

GBurns,

From a fianancial planning standpoint, at least IMHO as reformed CPA, when someone goes from being a renter to a buyer - they are much better off. A person may be well able to make a $600 house payment, but only if the down payment is made. If they have to borrow to make down payment the addition $200 per month makes the purchase of home impossible. This does not make them marginally solvent.

If the hardship distribution safe harbors - written by IRS - include down payment for primary residence. This may eliminate future hardship situation by resulting in lower monthly payment.

We allow hardships from all our K plans for down payment of residence. We require copy of contract and good-faith estimate in order to process distribution. We will gross up for taxes if asked.

As for 401(k) loan - the lenders don't see it on credit report but they do see it on paystubb. Things like child support, garnishments, and other deductions taken from pay never show up on credit report. They will see pay stub - the gross and all deductions. That, in addition to credit report and borrowers listing, are what lender bases ability to pay upon.

I don't live in fantasy land GBurns, I have 12,000 employees who work low tech manufacturing for single digit per hour rates. Many do not speak english as primary language. Hardships for home purchase are actually common in my group, as is the occurence of those who are better off deferring income on an after tax basis.

[mbozek]

For taxpayers in the lowest brackets a hardship loan may be the better option because the new tax law increases the amount of income taxed at the 10% rate and a married couple may get a greater tax benefit by using the standard deduction of about $8000 instead of itemizing the interest payments and taxes. It certainly better to increase the downpayment to reduce mortgage payments if there is little tax benefit to the mge deduction (e.g, someone in the 15%bracket benefits less from the deduction than some one in the 30% tax breacket).