Wednesday, September 21, 2022

Can I Take Out Money From 401k To Purchase Home

Don't Miss

How Long Do You Plan To Live In The House

How to Use Your 401k to Buy a House!

It costs money to buy a house theres a break-even point at which the money you save from renting and the wealth youre gaining in equity matches what you spent to get into your house, but it takes a few years to get there If you arent planning on living there for a long time, it might be better to rent and wait to buy after you move to wherever you are going next.

Can I Use My 401 To Buy A House

Disclosure: This post contains affiliate links, which means we receive a commission if you click a link and purchase something that we have recommended. Please check out our disclosure policy for more details.

For many would-be homeowners, the down payment is the biggest entry barrier to buying a house. While down payments can be as low as 3.5%, 20% is ideal if you want to secure a mortgage without monthly mortgage insurance fees.

If youre having trouble gathering funds for a down payment, you might find yourself considering using your 401 retirement fund as a convenient source of cash. While this is technically allowed, and could help you cover your down payment, it shouldnt be your first choice. There are some factors and drawbacks that you might want to consider before using your 401 to buy a house.

Well break down the pros and cons of making a 401 withdrawal for a home purchase, as well as some alternatives.

Making A 401 Withdrawal For A Home

Compared to a loan, a withdrawal seems like a much more straightforward way to get the money you need to buy a home. The money doesn’t have to be repaid and you’re not limited in the amount you can withdraw, which is the case with a 401 loan. Withdrawing from a 401 isn’t as easy as it seems, though.

The first thing to understand is that your employer may not even allow withdrawals from your 401 plan due to age. If they do allow employees to tap 401 funds early, you may have to prove that you’re experiencing a financial hardship before they’ll allow a withdrawal. Under the IRS rules, consumer purchases generally don’t fit the hardship guidelines.

You may be able to withdraw funds from a 401 plan that you’ve left behind at a previous employer and haven’t rolled over to your new 401. This, however, is where things can get tricky.

If you’re under age 59 1/2 and decide to cash out an old 401, you’ll owe both a 10% early withdrawal penalty on the amount withdrawn and ordinary income tax. Your plan custodian will withhold 20% of the amount withdrawn for taxes. If you withdraw $40,000, $8,000 would be set aside for taxes upfront, and you’d still owe another $4,000 as an early-withdrawal penalty.

Read Also: Should I Roll Over 401k Into Ira

How To Buy Your Dream House With Your Eyes Wide Open

For many, property and the American dream are inextricably linked its a huge milestone on the path to success and security. If youre looking to buy a house, its important to go into the process with as much information as possible. That way, you can strut confidently towards your own slice of the American dream.

If you dream of owning a home, well be the last to persuade you otherwise. But it shouldnt come at the expense of your financial security. Here are a few things to look at as you pursue home ownership.

Common 401 Loan Questions

Can You Take Money From 401k To Buy House

Can I borrow against my 401? Check with your plan administrator to find out if 401 loans are allowed under your employers plan rules. Keep in mind that even though youre borrowing your own retirement money, there are certain rules you must follow to avoid penalties and taxes.

How much can I borrow against my 401? You can borrow up to 50% of the vested value of your account, up to a maximum of $50,000 for individuals with $100,000 or more vested. If your account balance is less than $10,000, you will only be allowed to borrow up to $10,000.

How often can I borrow from my 401? Most employer 401 plans will only allow one loan at a time, and you must repay that loan before you can take out another one. Even if your 401 plan does allow multiple loans, the maximum loan allowances, noted above, still apply.

What are the rules for repaying my 401 loan? In order to be compliant with the 401 loan repayment rules, youll need to make regularly scheduled payments that include both principal and interest, and you must repay the loan within five years. If youre using your 401 loanto buy a primary residence for yourself, you may be able to extend the repayment period. What if I lose my job before I finish repaying the loan? If you leave or are terminated from your job before youve finished repaying the loan, you typically have 60 days to repay the outstanding loan amount.

Summary of loan allowances

Recommended Reading: Can I Buy 401k Myself

Why You Can Trust Bankrate

Founded in 1976, Bankrate has a long track record of helping people make smart financial choices. Weve maintained this reputation for over four decades by demystifying the financial decision-making process and giving people confidence in which actions to take next.

Bankrate follows a strict editorial policy, so you can trust that were putting your interests first. All of our content is authored by highly qualified professionals and edited by subject matter experts, who ensure everything we publish is objective, accurate and trustworthy.

Our reporters and editors focus on the points consumers care about most how to save for retirement, understanding the types of accounts, how to choose investments and more so you can feel confident when planning for your future.

Make A 401 Withdrawal

Your second option would be to make a direct 401 withdrawal for your home purchase. As mentioned above, this is the less desirable of the two options.

An early withdrawal would be classified as a hardship withdrawal. The IRS considers any emergency removal of funds from a 401 to cover an immediate and heavy financial need as a hardship withdrawal. Whether or not the purchase of a home using your 401 counts as a hardship withdrawal is a determination that falls to your employer, and you will need to present evidence of hardship before the withdrawal can be approved.

Regardless, you will still likely incur the 10% early withdrawal penalty. There are exemptions in place for specific circumstances, including home buying expenses for a principal residence. Qualifying for such exemptions is difficult by design, however. If you possess other assets that could be used for your home purchase, then you likely wont qualify for an exemption. Even if you do, your withdrawal will still be taxed as income.

You May Like: How Do I Rollover My 401k Into An Ira

How Much House Can You Afford

Generally speaking for conventional mortgage income qualifications, your monthly mortgage payment including principal, interest, property taxes and homeowners insurance shouldnt exceed 28% of your gross monthly income. Governmental loan programs may have higher percentage income qualifications. Youll also need to factor in any remodeling, landscaping or other home improvement projects you want to do both now and later to help determine if a particular house will fit into your longer-term budget.

Dont forget to calculate your other home expenses. Theres the down payment, mortgage payments, insurance, utilities, maintenance and taxes to name a few. Remember to think about how your income might grow over the years. Run the numbers on several different home price points, and calculate your down and mortgage payments to get a feel for what your ideal price range is.

Still Not Sure Ask A Financial Advisor

Can I Use My 401k To Buy a House?

For most home buyers, withdrawing or borrowing from 401 retirement funds to make a down payment on a house is short-sighted. But there may be exceptions depending on the state of your personal finances and overwhelming financial need.

For some people, hardship distributions or 401 loans could be a sensible solution.

A financial planner can help you weigh your current account balance against your long-term financial goals so you can better decide how to proceed.

You May Like: Can I Borrow From My 401k For A House

Using 401 For A Down Payment As A First Time Home Buyer: Pros & Cons

Like any other payment option, using 401 for a down payment as a first-time home buyer has advantages and disadvantages. Using 401 as a first-time home buyer might be better than other loans regarding interests and total amounts.

Still, the penalties and rules associated with early withdrawals might be a deal-breaker for some people. Therefore, before making any withdrawal, homebuyers should consider the pros and cons, so they are not left wondering how long their 401 will last.

Borrow Against Your 401

Borrowing from your 401 is generally the more advantageous option if you want to tap your plan for a down payment.

If your employers plan allows employees to take out loans against their 401 accounts, youll typically be able to borrow up to 50% of your vested account balance or $50,000, whichever is less.

Tip:

Youll then have to make more or less equal payments at least quarterly, with interest until youve repaid the loan. Youll typically need to repay it within five years.

Upsides

  • Wont affect your credit

Downsides

Learn More: 401 Loans: Should You Borrow Against Your Retirement?

Read Also: When Should You Rollover A 401k

Be Careful Using 401 For A Down Payment

The biggest challenge most buyers face when purchasing a home? Coming up with that big down payment. Even if your mortgage lender only requires a down payment of 5 percent, that still comes out to $10,000 for a modestly priced home of $200,000. Many buyers simply dont have that much cash lying around.

If you have a 401 plan at work, though, you might have a convenient source for down payment funds. You are allowed to borrow money from this retirement account for a down payment. You just have to pay back your loan with interest on time to avoid any penalties or taxes.

But does doing this make financial sense? That depends upon how badly you want the home, how close you are to retirement and how certain you are that you can pay back the loan on time.

Heather McRae, senior loan officer with Chicago Financial Services in Chicago, said that a 401 loan has helped several of her clients gather the funds they need for down payments. She considers it a smart financial move for borrowers who know they can handle the payback schedule.

If you dont have the money for a down payment and you dont have family members who are kind enough to gift you the down payment, youre kind of out of luck, McRae said. The 401 loan is often the best option for these buyers. If you havent saved the money for a down payment and youve fallen in love with a property, the 401 can make the purchase work.

Recommended Reading: Where Do You Get A 401k

If Im Considering A 401 Loan What Information Should I Get From My Plan Provider

Can a 401(k) Be Used for a House Down Payment?

If youre considering taking a loan from your 401, ask your plan administrator for the following information:

  • Whether or not loans are/are not permitted
  • The minimum dollar amount required to obtain a loan
  • The maximum number of loans permitted by the plan
  • The maximum dollar amount permitted
  • The term of repayment
  • Any interest rate information
  • Any required security for the loan
  • How repayment may be made
  • Any spousal consent requirements

Don’t Miss: Which 401k Investment Option Is Best

Two Ways To Use A 401 To Buy A House

Taking a 401 distribution

The first method you can use to borrow money from a 401k for a down payment is to withdraw money or take a distribution without intending to pay it back. Unfortunately, this method of using retirement funds to buy a house can have some expensive tax consequences.

While withdrawing from a 401 is always considered a taxable event, depending on your age, theres a good chance that youll be taxed on the same money twice. To start, all 401 distributions are taxed as ordinary income. However, if youre under the age of 59 ½, your withdrawal will be considered an early distribution and youll have to pay an additional 10% early withdrawal tax.

Using a 401 loan

Instead of withdrawing from a 401 for a house, it might be a better idea to use a 401 loan for your home purchase. As the name suggests, you have to pay back a 401 home loan eventually, but as long as you follow the rules, the money you borrow is not taxable. That fact alone can make it a more affordable option than taking a 401 withdrawal for a home purchase.

First, you have to pay attention to how much you can borrow. While not all 401 plans allow for loans, if yours does, youre allowed to borrow up to 50% of your vested account balance or a maximum of $50,000, whichever is less.

What Are The Cons

Besides the fees, your employer will likely stop their side of the match, if they were making one. Even when youre paying yourself back, your employer wont consider those funds a new contribution and therefore wont match it. It also might make it more difficult to qualify for a mortgage, as it can affect your debt-to-income ratio you should still be sure to shop around to find a lender that can offer you the best program that fits your financial needs. And of course, youll lose out on the compound interest your money would have been earning if youd left it in the account.

Of course, if you decide to withdraw rather than borrow from your 401, the main con is the giant tax hit youll suffer.

Also Check: How To Pull Money Out Of My 401k

Getting A 401 Loan For A Home

If you’d like to use your 401 to cover your down payment or closing costs, there are two ways to do it: a 401 loan or a withdrawal. It’s important to understand the distinction between the two and the financial implications of each option.

When you take a loan from your 401, it must be repaid with interest. Granted, you’re repaying the loan back to yourself and the interest rate may be low, but it’s not free money. Something else to note about 401 loans is that not all plans permit them. If your plan does, be aware of how much you can borrow. The IRS limits 401 loans to either the greater of $10,000 or 50% of your vested account balance, or $50,000, whichever is less. For example, if your account balance is $50,000, the maximum amount you’d be able to borrow is $25,000, assuming you’re fully vested.

In terms of repayment, a 401 loan must be repaid within five years. Your payments must be made at least quarterly and include both principal and interest. One important caveat to note: loan payments are not treated as contributions to your plan. In fact, your employer may opt to temporarily suspend any new contributions to the plan until the loan has been repaid. That’s significant because 401 contributions lower your taxable income. If you’re not making any new contributions during your loan repayment period, that could push your tax liability higher in the interim.

Weighing Pros And Cons

Should I Use 401k Money To Pay Off Debt And Buy A Home?

Before you determine whether to borrow from your 401 account, consider the following advantages and drawbacks to this decision.

On the plus side:

  • You usually dont have to explain why you need the money or how you intend to spend it.
  • You may qualify for a lower interest rate than you would at a bank or other lender, especially if you have a low credit score.
  • The interest you repay is paid back into your account.
  • Since youre borrowing rather than withdrawing money, no income tax or potential early withdrawal penalty is due.

On the negative side:

  • The money you withdraw will not grow if it isnt invested.
  • Repayments are made with after-tax dollars that will be taxed again when you eventually withdraw them from your account.
  • The fees you pay to arrange the loan may be higher than on a conventional loan, depending on the way they are calculated.
  • The interest is never deductible even if you use the money to buy or renovate your home.

CAUTION: Perhaps the biggest risk you run is leaving your job while you have an outstanding loan balance. If thats the case, youll probably have to repay the entire balance within 90 days of your departure. If you dont repay, youre in default, and the remaining loan balance is considered a withdrawal. Income taxes are due on the full amount. And if youre younger than 59½, you may owe the 10 percent early withdrawal penalty as well. If this should happen, you could find your retirement savings substantially drained.

Recommended Reading: How Much Can I Put In 401k

Tap Your Ira Or Roth Ira Instead

Best for: First-time homebuyers who need $10,000 or less for a down payment

You normally need to be 59½ to take penalty-free distributions from your IRA, but the IRS allows an exception for qualified first-time homebuyer distributions.

As long as you put any early distributions of up to $10,000 toward buying or building your first home, you wont have to pay the additional 10% tax on it.

Using Your 401k For A Down Payment

Theres no specific penalty exemption for home purchases when you pull money out of a 401k, so any money you take out will be classified as a hardship exemption. Youll be assessed a penalty of 10% on the amount withdrawn and youll have to pay income tax on it as well.

If possible, roll over the amount you want to withdraw to an IRA, so you can avoid paying the penalty. However, you cant roll over a 401k thats with an employer for whom you are still working. If you have an old 401k from a former employer, roll that. Since a rollover can take time to process, fill out the necessary paperwork as soon as possible.

Recommended Reading: Can I Withdraw 401k To Buy A House

More articles

Popular Articles