Can You Use Your 401k Funds To Buy A Home?

Buyers often wonder: “Can you use your 401k funds to buy a home?”

We researched three expert sites to find the answer:

1. First, Investopedia says: “Yes, but it’s not usually a good idea.”;
2. Then, Rocket Mortgage says: “There are good reasons for not using your 401(k) to buy a house.”; and
3. Finally, The Mortgage Reports concludes: “Financial advisors recommend borrowers tap their 401(k) funds only as a last resort”.

KEY TAKEAWAYS

• You can use your 401(k) funds to buy a home. By withdrawing funds or by taking a loan from the account.
• Withdrawing funds from your 401(k) are limited to your contributions. Also, you can avoid penalties by classifying it as a “hardship” withdrawal, but it is subject to income taxes.
• A 401(k) loan must be repaid-with interest while not subject to tax penalties or income taxes.
• Better alternatives exist like withdrawing from a Roth IRA.
• Or, you can take out an FHA or VA loan to buy your home.

 

What Is A 401(k)?

 

The Internal Revenue Code of the IRS allows 401(k) retirement plan contributions as tax deductions to help people prepare for retirement:

• The retirement plan accrues tax-free interest over time;
• However, the IRS limits accessing the funds until the account holder turns 59½ years old or 55 if they lost or left their job; and
• Early funds withdrawals incur a 10% penalty with the funds subject to income taxes.

The purpose of these limits and penalties is to make account holders accumulate enough money for a comfortable retirement. 

 

Can I Use My 401(K) to Buy a Home?

 

Let’s assume that you are under the age of 59 1/2 and still working.

Yes, since it’s your own money. but three experts don’t think it’s a good idea. Why?

Better options exist than removing funds from your valuable retirement account which can’t be replaced easily.

Also, a 401(k) early distribution is taxable with tax penalties too.

 

What Are The 401(k) Rules?

 

Your 401(k) account is supposed to be saved for your retirement. That’s why you get tax breaks every time you contribute to it. So, when you give to your 401(k) you get a tax deduction. Also, the money grows tax-free. Yet, the government limits your access to the funds until you are old enough to retire.

Not until you reach 59 1/2 years old are you supposed to withdraw funds. Or, the age of 55 if you lost or left your job.

Beware: If you take out funds before either age or qualifying employment status you will incur a 10% early withdrawal penalty on the sums withdrawn. Making it worst, you will also owe income taxes on the amount withdrawn.

 

401(k) Withdrawals versus 401(k) Loans

 

Let’s explore the difference between 401(k) loans and withdrawals.

 

401(k) Withdrawals

 

The only way to withdraw funds early from a 401(k) is to claim a hardship withdrawal. The IRS generally allows the funds withdrawal as a hardship if you claim the funds are “urgently” needed as a down payment for a principal residence.

The IRS will hit you with a 10% penalty on the withdrawal unless you can convince them that it meets very strict exemption rules. Yet, if the IRS waives the 10% penalty you still must pay income tax on the withdrawn amount.

Remember, the IRS only gives you an exemption on the amount necessary to satisfy your financial hardship needs. While the IRS doesn’t require repaying the withdrawn funds you can replenish your 401(k) with future contributions from your paychecks.

 

401(k) Loans

 

Know that not all plans allow 401(k) loans. However, the plans only allow a maximum of $50,000 to borrow.

Experts agree that “borrowing from your 401(k)” is more desirable than withdrawing the funds. Taking out a 401(k) loan doesn’t incur an early withdrawal 10% penalty. Also, you don’t pay income taxes on the loan amount received.

Still, because it is a loan you must repay it by paying yourself back. You must put the money back into the account. Also, you have to pay yourself the interest too at the prime rate plus one or two percentage points. Your 401(k) administrator (or plan provider) gives you the interest rate and repayment terms.

Also, the maximum repayment term is five years. Yet, taking out the loan to buy a principal residence gives you more time to repay it. Repayments do not count as contributions so no tax breaks occur. Plus, no employer matching contributions for your loan repayments. Likewise, your plan provider may not let you make contributions to your 401(k) until the repayment is made in full.

The amount you can borrow is limited to half your account balance or $50,000 whichever is less.

A benefit of a 401(k) loan is it won’t count towards your debt-to-income ratio, used by credit bureaus. Thus, it won’t hurt your credit score used to qualify you for a home mortgage.

 

The Cons to Using Your 401(k) To Buy A Home

 

Tapping your retirement plan to buy a home creates problems. Here’s how.

Diminishing your retirement savings not only hurts you with the initial drop in its balance but for its future growth.

For instance, you take out $50,000 from your account to buy a home. If your 401(k) is earning 7% annually, in 25 years your $50,000 will be worth $271,372. You lose that gain!

You are better off leaving the $50,000 in your 401(k) plan unless the equity in your new home can equal or better the $50,000 left in your 401k for 25 years.

 

Have questions?

 

Alternatives to Using Your 401(k)

 

Before using your 401(k) funds to buy a new home look at your other options.

 

VA Loan

 

If you are a veteran, an eligible service member, or the spouse of one. The Veterans Administration (VA) loan is a better option than taking funds out of your 401(k).

The VA loan is government-backed and includes lower interest rates with flexible terms. Such as no down payment. To qualify for the VA loan, you must meet one of these criteria:

• Served 181 days of active peacetime service; or
• Served 90 consecutive days of active wartime service; or
• Served more than 6 years with the Reserves or National Guard or at least 90 days under Title 32; with 30 of those days consecutively; or
• Veterans discharged because of disability have those service time requirements waived; or
• A spouse of a service member who lost their lives, either in the line of duty or resulting from an injury during active service.

Meeting one of these requirements allows you to get a Certificate of Eligibility for a VA loan.

 

FHA Loan

 

A government-backed Federal Housing Administration (FHA) mortgage makes it easier for first-time homebuyers to qualify. The benefits include lower credit score requirements and low-down-payment options. This is why an FHA loan is better than a 401(k) loan or a withdrawal.

Read our past blog posts explaining FHA loans in greater detail:

• What To Expect During The California Mortgage Process;
• How To Successfully Buy a Home;
• Improve Your Chances for Home Loan Approval; and
• Financing Tips for First Time Home Buyers.

 

Roth IRA

 

Two types of IRAs exist. A traditional IRA and a Roth individual retirement account which is more flexible than a 401(k) and a traditional IRA.

A Roth IRA is funded with your after-tax dollars which means they are tax-free when you withdraw those funds.

Yet, withdrawing the earnings in a Roth IRA can be subjected to income taxes and a 10% penalty depending on your age and how old your account is. You can withdraw earnings tax-free and no penalties if:

1. You are at least 59 ½ years old; and
2. You first contributed to the account at least five years ago.

Note: The Roth IRA 5-Year Rule “applies regardless of your age”. This means if you were 57 when you made your first contribution, you must wait until you reach 62 to avoid taxes.

 

Roth IRA First-Time Homebuyer Exception

 

A first-time homebuyers exception includes persons who didn’t own a primary residence during the past two years.

If you have a Roth IRA, you need to take a distribution from your IRA:

• You can take out up to $10,000 tax-free if the funds are used for a first-time home purchase;
• You won’t pay a 10% penalty or taxes; and
• The IRS requires you to use the funds within 120 days towards the purchase of your new home.

Can You Use Your 401k Funds To Buy A Home? – Conclusion

 

Yes, to the question: “Can you use your 401k funds to buy a home”?

Yet, while you might become tempted to tap into your 401(k) funds look at the other alternatives like:

• VA Loan;
• FHA Loan; or an
• IRA.

 

Thinking of Buying a San Diego Home?

 

Big Block Realty publishes many blog posts to educate home buyers nationally and in San Diego County. Our experienced Realtors number over 985 making us one of the largest non-franchise real estate brokerages in the country.

Why have so many Realtors joined us? They believe in us and the way we educate buyers and sellers to make the purchase and sale of homes in the greater San Diego region easier.

Contact us before starting your search for a new home in San Diego County. One of our Realtors can save you time and money while helping you find the ideal home for your family.

 

 

Steven Rich, MBA – Guest Blogger

 

 

Search Local Real Estate Below Or Use Our: Home Search Tool:

—

HAVE ANY QUESTIONS?

Let us know, we love to help:

Call: (800) 550 – 3209

or Click: www.BigBlockRealty.com/contact

— 

Connect with Big Block…

 

SUBSCRIBE TO OUR CHANNEL: https://www.youtube.com/@bigblockrealty?sub_confirmation=1

 

CONNECT WITH US ON SOCIAL HERE: https://bigblockrealty.com/social/

 

Find us on Instagram: https://www.instagram.com/BigBlockRealty_