| | Use Funds In 401K As A Downpayment September 27, 2006 |
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Use funds in a 401K as a downpayment for purchasing a home or a business? Most people think it is not possible to do that, but they are not correct. The US tax code does allow use of 401K funds as a downpayment without penalty as long a person goes about it the right and proper way. Of course, using funds in a 401K as a downpayment simply by withdrawing the funds and having total control over them yourself can lead to a ten percent penalty in addition to all taxes that must be paid, so that is obviously not the best way to do it.
Let’s say for instance that a person wants to purchase an existing business. They have contacted a business brokerage company and done the due diligence to choose a good business they would enjoy operating. The business is for sale for $100,000 because the current owners want to retire. After all expenses are paid the business ate the present time earns the owners about $70,000 per year. Most rules of thumb when it comes to purchasing businesses are that a business is worth between two and three times the owner’s cash flow, which is determined as the net profit plus any salary or other benefits paid to the owner. So, this business is really worth from $140,000 to $210,000 depending on the rule of thumb applied. Also the business includes about $30,000 in inventory which increases its value. This means the business is a bargain, but the person who wishes to buy it just doesn’t have the money in the bank and doesn’t have the proper resources to obtain a traditional loan from a bank or lending institution. In comes the business brokerage financial advisor who says to use funds in a 401K as a downpayment, without penalty.
How is this done? How can a person use funds in a 401K as a downpayment to buy a business? In essence the 401K is rolled over into a self-directed IRA, or individual retirement account. Then the IRA is directed to purchase the business. The IRA will own the business and the owner of the account will work for the business. This may sound complicated but it holds true to the spirit and the letter of the law as far as the IRS is concerned and allows many Americans to become owners of their own businesses and masters of their own destiny. The 401K account, originally set up for retirement purposes then also becomes the vehicle by which a person makes a very good living until retirement and is able to live the American dream of business ownership.
A person can also use funds in a 401K as a downpayment for a home. The IRS specifically allows a person to use 401K funds for purposes of home ownership. At times a person will have a great deal of money invested in an IRA but still have relatively little in the bank in traditional savings accounts. It is natural for this to occur because the 401K has the benefit of being tax deferred and also because so many employers will match a percentage of the funds deposited into an IRA, making it a very attractive vehicle for savings. Much more so to many people that simply putting money into a CD, savings bonds, or mutual funds where interest or dividends will be accrued, but which are taxable income at current rates, which for most people are in higher taxation brackets now that they plan to be in upon retirement.
The IRS indicates in their rules that an account holder may use funds in a 401K as a downpayment for a family home, or may use those funds for an emergency situation to avoid loosing a home through foreclosure. This indicates of course that the Federal government sees individual home ownership as a very positive benefit for the economy of the United States and for the individual account holder. Indeed, owning a home upon retirement and hopefully having it free and clear of mortgages is one of the financial safety nets that many Americans see as part of the American dream as well, and strive for all of their lives. Since the beginning of the nation known as the United States, when still a British colony, home ownership and land ownership were sought after as proof of having actually made it. Daniel Boone, the famous explorer and pioneer moved many times and always said he needed more “elbow room.” Americans always wanted to own land, own homes and own businesses, and for many years in fact only those who owned property were able to vote in elections, emphasizing the importance Americans have placed on owning a stake in the country and in the future. Of course in pioneer days there was no such thing as a 401K, and funds were not available. These days are different however. A person is able to use funds in a 401K as a downpayment for important things like home ownership and small business ownership, and through use of 401K funds in this manner, contributes to the growth of a healthy US economy.
Many people find routes to home ownership and business ownership through vehicles other than using funds in a 401K as a downpayment, and if other methods are available then they should certainly be checked and considered. However, use of funds in a 401K as a downpayment for an important venture such as home ownership or business ownership rally is one of the things that Congress had in mind when the 401K was created, or at least it is something that came to mind quickly and they approved totally. After all, the mission of Congress and the rest of the government in creating the 401K was to help Americans with retirement and with basic financial independence and security. Using funds in a 401K as a downpayment for a home or a business is one o0f the ways of reaching that security and independence
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