House bill caps tax-free 401(k) home withdrawals at $40,000 or 40%

Participants in 401(k), 403(b) and 457(b) plans could take tax- and penalty-free home-purchase distributions of up to $40,000, or 40% of their vested balance if larger, under a bipartisan House bill introduced Oct. 29.

The Homeownership Opportunity Act caps a qualifying distribution at the greater of $40,000 or 40% of the participant's vested balance. Reps. Greg Steube (R-Fla.) and Jimmy Panetta (D-Calif.) introduced it, with Rep. Mike Carey (R-Ohio) as an original cosponsor. Qualifying amounts used for a down payment or closing costs would be excluded from gross income and exempt from the 10% early-withdrawal penalty, 401(k) Specialist reported.

For the advisors who work with plan sponsors, the distribution scales with the account rather than sitting at a single flat amount. A participant with $300,000 vested could take $120,000, three times the floor. Plans adopting the feature would likely need a way to track optional repayments over three years, since repayment would not be required.

Distributions would cover the purchase of any primary residence, not only a first home. Participants would have three years to repay the money, and repayment would be optional. "Hardworking Americans who have spent years saving for their future shouldn't be penalized for wanting to buy a home," Steube said.

IRAs are excluded from the bill. They already allow a $10,000 penalty-free withdrawal for a first home, but that money stays taxable, so a saver with both a 401(k) and an IRA would face different tax treatment for the same down payment.

Because repayment would be optional, a participant who takes a distribution and puts nothing back ends with a permanently smaller retirement balance. The 401(k) Specialist report on the bill framed that cost to retirement security as the trade-off against wider access to homeownership.