If you are having trouble finding a sufficient down payment for a home, you may be able to tap into your retirement funds – but you may face penalties for early withdrawal of your funds (typically 10% of the amount), and moving tax-deferred funds may incur unpleasant tax ramifications.
In general, the closer you are to retirement, the worse of an idea this becomes. You have less time to repay and make up for the lost retirement fund opportunities while simultaneously saddling yourself with mortgage debt. A young couple that is just starting out may find this approach more appealing.
Assuming you decide that this is a better use of some of your retirement funds, you have several options to choose from aside from a straight-up, penalty-laden early withdrawal.
- IRA Withdrawals for First-Time Homebuyers – If you are a qualified first-time homebuyer, you can withdraw up to $10,000 from a traditional IRA without penalty, although you will still need to pay taxes on the withdrawal at your current tax rate. The home purchase must take place within 120 days of withdrawal.
Since Roth IRAs are funded with after-tax money, any money that you have in a Roth IRA account for at least five years can be removed without taxes or penalties (earnings less than five years old are subject to taxes).
The homebuyer exception only applies to IRAs and not 401(k)s or similar programs.
- 401(k) Loan – If your plan allows it, you may be able to borrow half of your balance up to $50,000 (assuming you are vested). You will need to pay the loan back plus all of the interest within a set period – usually five years, but it may be possible to receive terms up to 15 years.
Beware – should you lose your job, your former employer may demand that the balance be paid immediately. If you cannot repay, the loan becomes a withdrawal with appropriate taxes and penalties.
- Hardship Withdrawal – Most 401(k) plans and similar programs allow for early withdrawal of some of your money under a “hardship” provision, if you have no other financial means available.
Hardship status waives the 10% penalty if you are not a first-time homebuyer, but you still have to pay the taxes associated with all tax-deferred vehicles. You also cannot contribute to that plan for at least six months after the withdrawal.
For all of the methods that will require paying taxes, you may be able to blunt the effect by making the withdrawal/home purchase relatively early in the year. That allows you to claim as much of the mortgage interest deduction as you can (including any points you paid at closing).
If the sale falls through, you need to roll the funds back into the IRA quickly to avoid penalties. With the 401(k) hardship path, you are stuck in the short-term because of the 6-month limitation and IRS rules that prevent you from rolling the hardship money into a different plan.
Even if you can acquire the funds without penalties and take a minimal tax hit, it is often a bad idea to use retirement funds toward a home purchase. You are trading the opportunity costs of the retirement fund for the amount of home appreciation minus the taxes, interest, and penalties you will pay.
However, if the extra down payment amount allows you to get a superior rate, avoid PMI (private mortgage insurance), and cut down on collective interest payments on your home, you could still come out ahead – depending on the relative performance of your retirement plan vs. the appreciation on your house.
Only you can decide which is best for you – but make sure you understand all of the tax and penalty implications, and make reasonable assumptions when you do your cost-benefit analysis. You may also consider whether waiting, or buying a smaller house, would be a better option.
Winnie Sun is a registered representative with, and securities offered
through LPL Financial, member FINRA/SIPC. Investment advice offered through Sun Group Wealth Partners, a
registered investment advisor and a separate entity from LPL Financial.