Benefits Of Borrowing From Your 401k To Buy A Home
The great thing about 401k loans is that they dont count towards your . Using a 401k loan to finance your down payment can put you in a more favorable position for financing your mortgage. And, these loans are not reported to the credit bureaus, so they dont impact your credit score. It can also be beneficial to borrow from your 401k as a first time home buyer in order to make a higher down payment, especially in a competitive . That said, you should consider the monthly payments on your 401k loan along with your monthly mortgage payment to ensure that these payments are within your budget.
Withdraw From Your Ira
While using a 401 for a down payment may be costly at tax season, theres a good chance you might have better luck taking a distribution from an IRA instead. In this case, the rules around distributions depend on what kind of IRA you have. For example, if youre withdrawing from a Roth IRA, you can take a tax-free distribution at any time , provided that youve had the account for at least five years.
With a traditional IRA, however, the rules are a little bit different. Here, the tax scenario works similarly to a 401, where your distributions are taxed as ordinary income and youre typically taxed on early withdrawals. However, there is an exception for first-time homebuyers: They are allowed to borrow up to $10,000 to put towards their down payment without having to pay the extra 10% early distribution tax.
Be Careful Of The Timing Rules
There is a very important timing rule associated with this exception. The closing must take place within 120 day of the date that the withdrawal is taken from the IRA. If the closing happens after that 120 day window, the full 10% early withdrawal penalty will be assessed. There is also a special rollover rule for the first time homebuyer exemption which provides you with additional time to undo the withdrawal if need be. Typically with IRA’s you are only allowed 60 days to put the money back into the IRA to avoid taxation and penalty on the IRA withdrawal. This is called a “60 Day Rollover”. However, if you can prove that the money was distributed from the IRA with the intent to be used for a first time home purchase but a delay or cancellation of the closing brought you beyond the 60 day rollover window, the IRS provides first time homebuyers with a 120 window to complete the rollover to avoid tax and penalties on the withdrawal.
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How Much You Can Withdraw
You cant just withdraw as much as you want it must be the amount necessary to satisfy the financial need. That sum can, however, include whats required to pay taxes and penalties on the withdrawal.
The recent reforms allow the maximum withdrawal to represent a larger proportion of your 401 or 403 plan. Under the old rules, you could only withdraw your own salary-deferral contributionsthe amounts you had withheld from your paycheckfrom your plan when taking a hardship withdrawal. Also, taking a hardship withdrawal meant you couldn’t make new contributions to your plan for the next six months.
Under the new rules, you may, if your employer allows it, be able to withdraw your employers contributions plus any investment earnings in addition to your salary-deferral contributions. Youll also be able to keep contributing, which means youll lose less ground on saving for retirement and still be eligible to receive your employers matching contributions.
Some might argue that the ability to withdraw not just salary-deferral contributions but also employer contributions and investment returns is not an improvement to the program. Heres why.
Dividing Your 401 Assets
If you divorce, your former spouse may be entitled to some of the assets in your 401 account or to a portion of the actual account. That depends on where you live, as the laws governing marital property differ from state to state.
In community property states, you and your former spouse generally divide the value of your accounts equally. In the other states, assets are typically divided equitably rather than equally. That means that the division of your assets might not necessarily be a 50/50 split. In some cases, the partner who has the larger income will receive a larger share.
For your former spouse to get a share of your 401, his or her attorney will ask the court to issue a Qualified Domestic Relations Order . It instructs your plan administrator to create two subaccounts, one that you control and the other that your former spouse controls. In effect, that makes you both participants in the plan. Though your spouse cant make additional contributions, he or she may be able to change the way the assets are allocated.
Your plan administrator has 18 months to rule on the validity of the QDRO, and your spouses attorney may ask that you not be allowed to borrow from your plan, withdraw the assets or roll them into an IRA before that ruling is final. Once the division is final, your former spouse may choose to take the money in cash, roll it into an IRA or leave the assets in the plan.
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Should You Tap Your 401 To Buy A House
Borrowing from your 401 isnt advisable, but some experts say it can be done in a pinch.
I wouldnt recommend it, but I will say that a loan from your 401 has a flexible repayment schedule, says Zhouhere. You can pay within the five years, or you can pay faster than that without penalty. You can also pay what you borrowed through payroll deductions, but using the after-tax dollars.
Others urge homebuyers to never remove money from their 401 to buy a house.
Ive been representing lenders and borrowers for 15 years, and Id never advise this, says Matthew Carter, an attorney at Las Vegas Inc and Go.
Buyers might think they are just borrowing the money from themselves, but they are really borrowing it from the future. Theyre losing the interest and value they can build on that money to purchase a home that will likely put them into further debt, adds Carter.
Homeownership comes with a lot of unexpected costs, and borrowing from your future to suffer those costs is reckless, he says.
Still, in the current competitive real estate market, tapping your 401 might be a worthwhile move, as long as you run the numbers and know that you can afford the fees.
Rising home values alone should make people seriously consider borrowing from their 401, says Chris Barnett at eXp Realty in Birmingham, AL.
Tapping your 401 fund is ideal if you need quick cash for short-term liquidity, Zhouhere says.
Can You Use Your 401k To Buy A House Without Penalty In 2022
There are limits to how much you can withdraw from your 401, so likely you wont be able to purchase your house outright. Typically, this limit is 50% of your 401s vested account balance or $50,000, whichever is less. And of course, if you choose to make a withdrawal, all penalties and taxes would apply.
Because of this limit, if you do decide to dip into your 401, it is best used as a down payment source.
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If I Dont Use My 401 To Buy A House When Can I Use My 401
Put simply, 401s are meant to be retirement accounts, meaning that the money is ideally supposed to be used when you reach retirement age. The early withdrawal taxes that 401s and IRAs use are supposed to incentivize you to leave the money untouched until you reach retirement age.
However, hardship withdrawals do exist to allow you to borrow money early under extenuating circumstances.
If Im Considering A 401 Loan What Information Should I Get From My Plan Provider
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
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Request A Hardship Withdrawal
In certain circumstances you may qualify for whats known as a hardship withdrawal and avoid paying the 10% early distribution tax. While the IRS defines a hardship as an immediate and heavy financial need, your 401 plan will ultimately decide whether you are eligible for a hardship withdrawal and not all plans will offer one. According to the IRS, you may qualify for a hardship withdrawal to pay for the following:
- Medical care for yourself, your spouse, dependents or a beneficiary
- Costs directly related to the purchase of your principal residence
- Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for you, your spouse, children, dependents or beneficiary
- Payments necessary to prevent eviction from your principal residence or foreclosure on the mortgage on that home
- Funeral expenses for you, your spouse, children or dependents
- Some expenses to repair damage to your primary residence
Although a hardship withdrawal is exempt from the 10% penalty, income tax is owed on these distributions. The amount withdrawn from a 401 is also limited to what is necessary to satisfy the need. In other words, if you have $5,000 in medical bills to pay, you may not withdraw $30,000 from your 401 and use the difference to buy a boat. You might also be required to prove that you cannot reasonably obtain the funds from another source.
Using Your 401 For A First
If youre still thinking that you might want to go this route, its important to consider all the costs that will be part of owning a home, to make sure that youre not using your 401 as a way to fund a purchase that might be difficult to maintain. Looking at your retirement account balance might make you feel as though you have more money than you actually have coming in on a regular basis.
Buying a home might be the biggest purchase you make, but its important to remember that its not a one-time expense. Owning a home means regular costs for maintenance, upkeep, insurance, property taxes and much more. Its easy to get caught up in the excitement of house hunting and inadvertently make a first-time home buyer mistake that leaves you without sufficient funds to pay the ongoing expenses a home requires.
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Withdrawal Options Are Not The Same As Ira’s
First you have to acknowledge that different types of retirement accounts have different withdrawal options available. The withdrawal options for a down payment on a house from a 401 plan are not the same a the withdrawal options from a Traditional IRA. There is also a difference between Traditional IRA’s and Roth IRA’s.
Hardships Early Withdrawals And Loans
Generally, a retirement plan can distribute benefits only when certain events occur. Your summary plan description should clearly state when a distribution can be made. The plan document and summary description must also state whether the plan allows hardship distributions, early withdrawals or loans from your plan account.
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Alternatives To Using Your 401 To Buy A House
Even if youre short on cash and facing hardship, there are other options you might want to consider before tapping into your 401 account to cover the down payment on a house.
IRA Account
If you have an IRA, you should look there for extra funds before considering an early withdrawal from your 401. IRAs are built with special provisions for first-time home buyers, which the IRS defines as anyone who hasnt owned a primary residence within the previous 2 years.
Under these provisions, first-time home buyers are allowed to withdraw up to $10,000 without incurring the 10% penalty. However, that $10,000 is still subject to state and federal income taxes. If your withdrawal exceeds $10,000, then the 10% penalty is applied to the additional distribution.
A Roth IRA is an even better option, if you have one. Some plans allow you to make a hardship withdrawal, and up to $10,000 can be withdrawn tax-free for the express purpose of a first-time home purchase.
FHA Loan
A Federal Housing Administration loan is a government-backed mortgage with looser requirements designed to make it easier for first-time home buyers to purchase a property. This includes low down-payment options and lower credit score requirements. For this reason, an FHA loan may be a better option than making a withdrawal from your 401.
- Size of your down payment
Home Equity Line Of Credit
Instead of fixed-term repayment, you get a variable repayment and interest rate. You may opt for an interest-only repayment, but most often that comes loaded with a balloon payment, Poorman says, and may be tough to afford. Keep in mind that with a variable interest rate loan, you could see your rates go up over time.
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Tips On 401 Withdrawals
- Talk with a financial advisor about your needs and how you can best meet them. Finding a qualified financial advisor doesnt have to be hard. SmartAssets free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- If youre considering withdrawing money from your 401 early, think about a personal loan instead. SmartAsset has a personal loan calculator to help you figure out payment methods.
Find Ways To Increase Your Income Instead Of Using 401k Withdrawals For Your Home Purchase
A side hustle is one way you can take control of your income. You could also find a part-time job, ask for a raise or find a better paying job. As you increase your income, you can increase your savings for this big goal.
There is no shortage of side hustle ideas. Take some time to uncover the right fit for your goals. Want some help setting up your side hustle? Take advantage of our free step-by-step side hustle guide.
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What Are The Borrowing Limits For A 401
In general, you can only borrow up to 50% of your vested account balance or $50,000, whichever is less. Some plans may offer an exception if your balance is less than $10,000 you may be allowed to withdraw the entire amount. With a withdrawal, there are no limits on the amount, assuming your plan allows you to do so.
Still Not Sure Ask A Financial Advisor
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.
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Take An Early Withdrawal
Perhaps youre met with an unplanned expense or an investment opportunity outside of your retirement plan. Whatever the reason for needing the money, withdrawing from your 401 before age 59.5 is an option, but consider it a last resort. Thats because early withdrawals incur a 10% penalty on top of normal income taxes.
While an early withdrawal will cost you an extra 10%, it will also diminish your 401s future returns. Consider the consequences of a 30-year-old withdrawing just $5,000 from his 401. Had the money been left in the account, it alone would have been worth over $33,000 by the time he turns 60. By withdrawing it early, the investor would forfeit the compound interest the money would accumulate in the years that follow.
Is There A 401 First
Unfortunately, at this time, there is no such thing as a first-time homebuyer 401 withdrawal exception. While there is an IRA exemption that lets qualified, first-time homebuyers borrow up to $10,000 from an IRA without paying tax on the early deduction, this exemption does not currently exist for those borrowing from a 401.
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Why You Dont Need To Borrow From Your 401
Did you know a 20% down payment is not necessary? Have you heard its perfectly acceptable to use gift money toward your new home down payment? Lets not forget there are down payment assistance programs that come in the form of grant money, forgivable loans, and non-forgivable loans. There are even some loan programs like the VA loan or USDA loan that have a zero down payment requirement.
From a 401 investment standpoint, Country Financial Investment Solutions Representative Mike Boese agrees that its not a great idea to take from your 401 for a down payment. According to Boese, You are typically borrowing pre-tax funds and paying back with post-tax money. The other big negative people fail to realize is the opportunity cost. You are losing the ability to earn returns on the money you have taken out.”
