- Experts generally advise against using your retirement savings to fund a home purchase.
- You could incur a 10% penalty as well as any income taxes owed on the 401(k) withdrawal.
- If you get a 401(k) loan, you can avoid these costs. But you'll miss out on growth and get no employer match while paying it back.
Retirement savings are for the future, for a day when you're no longer working and need a source of income to pay the bills.
But what if retirement savings are the only savings you have, and you need money now for something big ... like a house? It can't hurt to just borrow some cash from your 401(k), can it?
In fact, experts say borrowing money from your retirement savings is generally a bad idea. In most cases, using your 401(k) for a home down payment has more drawbacks than benefits.
401(k) withdrawal for a home purchase: Is it a good idea?
If you have a lot of cash tucked away in your retirement savings, you might be wondering what the harm is in taking a little bit out to benefit you right now.
But in addition to potentially harming your long-term savings goals, taking an early withdrawal from your 401(k) can be expensive.
401(k) withdrawal rules for buying a home
First, you'll need to check with your plan administrator to see if early withdrawals are allowed, and under what circumstances. You may only be able to take money out with something called a 401(k) hardship withdrawal, which allows account holders to withdraw money penalty-free if they have an "immediate and heavy financial need," per the IRS.
The IRS leaves it up to employers to determine what meets the requirements for a hardship withdrawal, so you'll need to talk to your plan administrator to see if you can go this route. You'll also still need to pay income taxes on these funds.
A regular, non-hardship early withdrawal from a 401(k) comes with a 10% penalty in addition to any income taxes owed on that withdrawal.
If you're 59 1/2 or older, you can withdraw funds from your 401(k) as you like without paying a penalty. But you will still owe income taxes on any money you take out, unless you have a Roth 401(k).
Other options for using your retirement savings for a home purchase
An early withdrawal isn't the only way to get money out of your 401(k) before you reach retirement age. You may also be able to take out a 401(k) loan, which doesn't come with a penalty but does need to be paid back within a certain period of time.
If you have an IRA, you have the ability to take out up to $10,000 without penalty to cover your costs if you're a first-time homebuyer. But you'll still pay income taxes on this amount.
If you have a Roth IRA, you can withdraw the money you contributed to the account at any time without penalty or tax implications, because you already paid taxes on this money. Roth IRA earnings can be withdrawn for a first-time home purchase (up to $10,000) as long as you've had the account for at least 5 years.
Tax implications of a 401(k) withdrawal for a home purchase
Let's take a closer look at the penalties and taxes you might incur from a 401(k) home purchase withdrawal.
If you're under 59 1/2 years old and you don't meet your plan's requirements for a hardship withdrawal, you'll pay a 10% penalty to the IRS for taking this money out.
Additionally, 20% will be withheld to cover the income taxes that will need to be paid on this amount. If you end up owing less than this, you'll get some back when you file your taxes and get your refund.
What does this look like in practice? Say you want to borrow $30,000 from your 401(k) to cover your down payment and closing costs. You ultimately won't end up pocketing the full $30,000. First, you'll pay the 10% penalty, which amounts to $3,000 in this example.
Another 20% will be withheld to cover your income tax liability. This means you'd have $6,000 withheld on a $30,000 withdrawal. Keep in mind, you may owe more or less than this come tax time, depending on your tax bracket and your state and local income tax rates.
This means that on a $30,000 early withdrawal, you'll pocket $21,000 of that when all is said and done.
How to borrow against 401(k) to buy a house
Instead of withdrawing money from your 401(k), you also have the option to take out a loanhttps://www.businessinsider.com/personal-finance/401k-loan. This is generally better than a withdrawal, since you won't owe any taxes or penalties on the money you borrow — provided you're able to pay it back on time.
If your plan allows 401(k) loans, you can borrow up to 50% of your vested balance, up to a maximum loan amount of $50,000.
Generally, 401(k) loans need to be paid back within five years, but the IRS makes an exception for those who use the funds to purchase a primary home. Talk to your plan administrator to find out how long you would have to pay back the loan in this case, and what would happen if you were to leave the company and no longer be an employee. If you lose your job, the loan may be due at the same time as your taxes that year.
You'll pay interest on a 401(k) loan, but that interest goes back into your account, so you're essentially paying yourself.
Some plans don't allow contributions while you're paying back a 401(k) loan, so you may not get to add to your savings or take advantage of an employer match until you've fully paid the loan off.
As long as you pay off your 401(k) loan according to its terms, you won't incur any penalties or taxes. But if you don't pay it off in time, it will be considered a withdrawal and subject to applicable penalties and income taxes.
Pros and cons of using your 401(k) for a down payment
A big reason homebuyers consider tapping into their 401(k)s to fund a home purchase is that it's a large amount of savings that they don't have elsewhere. To buy a home, mortgage borrowers often need to bring thousands or even tens of thousands of dollars of their own money to the table.
This is the main "pro" of using this money — it's a large sum that's available to you now, rather than having to wait to save for a down payment and potentially miss out on home appreciation.
Depending on how much you have saved and how far you are from retirement, you might decide that paying for a home purchase with 401(k) funds makes sense for you. Just make sure you understand the risks.
Risks of using your 401(k) to fund a home purchase
You might miss out on appreciation
One of the main drawbacks of borrowing from your retirement fund is that you could be missing out on making money for your future. Financial planner Brian Pirri says when you take money out of an account that's meant to grow over time, you're essentially taking yourself out of the market — which means you could lose out on substantial appreciation that comes from compound interest.
Paying back a loan could strain your budget
If you borrow money from your retirement savings with a 401(k) loan, your paycheck will be reduced by the amount you owe each month. This could be problematic if you're on a tight budget, particularly when you factor in the new costs you'll be taking on as a homeowner. Not only will you be taking on a mortgage payment, but you'll also need to budget for utilities, regular home maintenance, and repairs.
You may face a tax penalty
It may sound appealing to dip into money you've already saved, but because 401(k) savings enjoy certain tax advantages, pulling money out early can be expensive. You may pay both a penalty as well as income taxes on the amount you withdraw.
"The government doesn't want people taking funds out early, and they will hit you with a 10% fee for doing so," Pirri says.
You may not get approved for your mortgage
If you borrow money from your 401(k) to cover your down payment, your mortgage lender will view 401(k) loans like they would any other kind of debt, Pirri says.
If a 401(k) withdrawal results in a higher debt-to-income ratio, you may not get approved for the same amount you would have without withdrawing.
Alternatives to withdrawing from your 401(k) for a home purchase
If you're in the market to buy a home but you're struggling to come up with the money you need for a down payment, it may be wiser to wait until you have more saved or look around for programs that can help.
Consider low or no down payment mortgages
Some types of mortgages allow down payments as low as 3%. Others require no down payment. Though a 20% down payment will enable you to avoid paying for mortgage insurance, down payments of that size are far from the norm.
- Conventional loansrequire a minimum down payment of 3%.
- FHA loansallow down payments of 3.5%.
- VA loans, which are available to veterans and current military members who meet minimum service requirements, allow 0% down payments.
- USDA loans, which you can get if you live in an eligible rural area and meet income limits, also allow 0% down payments.
Keep in mind, though, that the less you put down, the more you'll need to borrow. You can use a mortgage calculator to see how different down payment amounts could end up impacting your monthly payment.
Search for down payment assistance
Your city or state may offer first-time homebuyer programs that include down payment assistance in the form of loans or grants. Local non-profits may also offer assistance. Talk to your local housing authority or housing finance agency to find out what's available to you.
See what lender assistance is available
Many mortgage lenders offer low-income or first-time homebuyer loans that come with affordable features like down payment assistance.
These programs are unique to individual lenders, so the type of assistance you could get varies. For example, Chase Mortgage offers a 3% down loan called the DreaMaker mortgage that can be combined with the lender's Homebuyer Grant, which offers up to $7,500 for borrowers in eligible areas. Rocket Mortgage, another popular mortgage lender, offers a product called a ONE+ mortgage, which allows down payments of just 1% for borrowers who meet income limits.
401(k) withdrawal for a home purchase FAQs
Can I use my 401(k) to buy a house?
You can use your 401(k) to buy a house, but depending on how you go about it, this can be expensive. An early 401(k) withdrawal comes with a 10% penalty on top of taxes. A 401(k) loan is an option, but you'll need to pay it back over a certain period of time, and you'll miss out on appreciation in the meantime.
Is buying a home considered a hardship for 401(k)?
Whether a home purchase qualifies as a hardship for the purposes of a 401(k) early withdrawal depends on your plan. Your plan administrator can tell you for sure. If it doesn't qualify as a hardship, standard penalties will apply to the withdrawal.
Can I take money out of a 401(k) to buy a house without a penalty?
If you get a 401(k) loan, you can avoid paying early withdrawal penalties and income taxes as long as you pay it back in time. The maximum amount you can borrow from your 401(k) is 50% of your vested balance, up to $50,000. If you withdraw the funds rather than getting a loan, you will pay a 10% penalty.
What proof do you need for a hardship withdrawal?
For a 401(k) hardship withdrawal, you'll generally need to provide documentation related to the specific hardship you're facing. For a home purchase, this may mean showing that you don't have the funds elsewhere to afford a down payment. Talk to your plan administrator for specifics, since requirements can vary.
Is it worth withdrawing from a 401(k) for a home purchase?
While withdrawing money from your 401(k) can make it easier to purchase a home, you'll incur a 10% penalty when you do so and owe taxes on those funds. It can also be risky to take money out of your retirement savings, since you'll miss out on appreciation over the years and have less money available when you retire.