Key Takeaways
- You may be able to take out a penalty-free loan from your 401(k) to buy a home, but you’ll still owe taxes on the amount you withdraw.
- Withdrawals over the limit or that don’t qualify for penalty-free withdrawal are still subject to a 10% penalty for borrowers under 59 ½.
- The amount you’ll lose in potential interest and growth of your retirement savings might not be worth the withdrawal.
Purchasing a home is a big step, and one of the biggest hurdles to achieving this financial goal is saving up for the down payment. If you’re trying to scrape together money to buy a home, you might wonder if you can tap into your 401(k) or other retirement savings accounts to bridge the gap.
Withdrawing money from your retirement account before you reach the age of 59 ½ usually incurs a 10% fee. However, in some cases – like using the money for a home purchase – you might be able to make an early withdrawal without paying the penalty.
Even so, many experts recommend using this option as a last resort, because you lose out on potential earnings in your retirement account. Read on to learn more about using your 401(k), IRA or other retirement savings to buy a home and if it’s a good option for you.
Is It Possible to Buy a Home With Retirement Savings?
The short answer is yes. You are always able to withdraw money from your retirement savings, whether it’s a 401(k), IRA or another account. However, you might be charged a penalty fee on your withdrawal if you’re under the age of 59 ½, and depending on if your account is a traditional or Roth account, you’ll also owe income tax on the amount withdrawn.
There are some exceptions available for first-time homebuyers, but the rules depend on the type of account you are withdrawing from.
Buying a Home With 401(k) Funds
There are two different ways you can use 401(k) funds to buy a home. You can make an early withdrawal or take out a 401(K) loan, each with their own rules.
“If you take a hardship withdrawal, you’ll typically face a 10% early withdrawal penalty if you’re under 59½, along with income tax on the withdrawn amount,” says Jordan Leaman, a certified financial planner and mortgage wealth advisor with Churchill Mortgage. “However, if you take a loan from your 401(k), you’ll generally avoid the penalty, but must repay the loan within a specified timeframe.”
Because it doesn’t incur the early withdrawal penalty, a 401(k) loan is the preferred choice, but not every 401(k) plan may offer this option. Additionally, you’ll be subject to a maximum withdrawal amount determined by your plan provider and you’ll have to pay back what you borrow with interest.
Buying a Home With IRA Funds
“Similar penalties and taxes apply to withdrawals from traditional IRAs and other retirement accounts, although Roth IRAs allow penalty-free withdrawals of contributions – but not earnings– for a first-time home purchase,” says Cliff Ambrose, a federal retirement consultant, founder and wealth manager at Apex Wealth.
There are two key benefits to using money from a Roth IRA for a home purchase. First, you can take out up to $10,000 as a first-time home buyer without an early withdrawal penalty. Second, you don’t owe income taxes on the amount, since Roth IRAs are funded with after-tax dollars.
According to Leaman, you can withdraw up to $10,000 without an early withdrawal penalty from a traditional IRA for a first-time home purchase as well, but income tax will still apply. “Other retirement accounts may have similar provisions, but it’s essential to review the specific rules and penalties associated with each account type,” he says.
Should You Use Your Retirement Savings to Buy a Home?
So, it is possible to buy a home with retirement funds, but is it a good idea?
“Using retirement funds to buy a home can be a double-edged sword,” says Leaman. “While it may provide immediate access to funds for a down payment, it can also jeopardize long-term retirement savings.”
You could incur a penalty or have to pay income tax on the amount you withdraw, which is an upfront cost you’ll need to be prepared for. But you’ll also need to account for the lost gains from a lower retirement account balance. “It’s essential to consider the opportunity cost of removing funds that could otherwise grow tax-deferred over time,” Ambrose says.
While $10,000 might seem like a relatively small withdrawal, you could be missing out on thousands of dollars in growth over time due to compound interest. Leaman and Ambrose both say that if you have an alternative route to saving for a down payment, you should take it in order to avoid tapping into retirement funds and negatively impacting your future returns.
“Alternatives to using retirement funds for a home purchase include saving more aggressively, exploring down payment assistance programs, negotiating with sellers or considering alternative housing options such as renting or co-ownership arrangements,” says Ambrose. “Ultimately, the decision depends on individual financial circumstances, goals and risk tolerance. Consulting with a financial advisor is advisable to assess the best course of action.”
