Buzz
Is purchasing a house with your retirement funds a smart move? That’s the question one of our readers is wrestling with this week.
Every Monday, we dive into one of your most urgent personal finance inquiries by consulting several financial experts for their advice. If you have a general money question, concern, or just want to discuss something finance-related, leave it in the comments or email me at [email protected].
This week’s inquiry comes from Jack:
Is it a wise decision to tap into retirement savings for purchasing a home? This includes options like 401(k), Roth IRA, and pension funds. Are there penalties for early withdrawals? Are there limits on how much you can withdraw? Is this a better alternative to taking out a loan from a bank? As a first-time homebuyer, I’m seeking advice.
Here’s what experts generally advise about an issue that impacts everyone differently—if you’re looking for tailored advice, it’s best to consult a financial planner.
Be Aware of Fees and Penalties
Jack, this is a pretty common personal finance question, and as with most things, the answer depends on your specific circumstances. However, in general, using your retirement funds should be a last resort.
The main distinction to make regarding your question is whether you’re considering a withdrawal or a loan, says Michael Ciccone, a Certified Financial Planner from New Jersey. You can withdraw funds, but you’d face a 10 percent penalty, plus income taxes on the amount withdrawn (if it’s from a pre-tax account like your 401(k)). Additionally, it will obviously reduce your retirement savings.
There’s an exception for first-time homebuyers that lets you withdraw up to $10,000 penalty-free from an IRA for the purchase of your primary residence (though you’ll still pay income tax). If you’re married, both you and your spouse can take advantage of this. Also, if your Roth IRA has been open for at least five years, you can withdraw contributions without taxes or penalties (just not the earnings).
Alternatively, you might be able to take a loan from your 401(k), which would need to be repaid over the next five years (although homebuyers may request an extension), with interest. If you decide to do this, you’re limited to borrowing either $50,000 or 50 percent of your vested account balance, whichever is smaller. Be sure to check with your HR representative to confirm if your plan allows it. (Note that if you leave your current job, you may be required to repay the loan in full immediately, or it will convert into a withdrawal, subject to taxes and penalties.)
However, keep in mind that this could significantly impact your retirement savings. Even though you’re paying back interest, it might not match the rate of return you would have otherwise earned. The true benefit of a retirement account lies in the compound interest. According to a Fidelity study, “a quarter of participants who take loans reduce their retirement savings contributions in their workplace savings plan, and 15 percent stop contributing entirely within five years of taking a loan.” Consider this: If you can’t afford a down payment without tapping into your retirement funds, how will you manage mortgage, insurance payments, and still save? It won’t simply resolve itself.
“I wouldn’t recommend using retirement funds to purchase a home, unless you only need a small amount to bring you over the 20 percent threshold and avoid PMI, for example,” advises Ciccone.
Instead of dipping into your retirement savings, Ciccone suggests exploring other options, such as:
Looking for down payment assistance programs (many states offer them)
Asking a family member for a loan, if possible
Seeking a mortgage that doesn’t require a 20 percent down payment or paying PMI
The last piece of advice is crucial. “Make sure you don’t deplete your cash reserves entirely for your down payment,” says Ciccone. “Owning a home can be costly, and you never know when unexpected repair bills or other financial emergencies, like major medical costs or job loss, might arise.”
It may feel overwhelming to gather 20 percent for a down payment, but the national average is much lower than that. I’d suggest focusing on building your cash reserves, even if it means postponing homeownership for a few more years.
“It’s better to start with a less expensive home than to tap into retirement funds for the initial purchase,” says Mary McDougall, a Wealth Management Advisor from Merrill Lynch Wealth Management in Minneapolis. “A mortgage typically comes with the added benefit of some interest being tax-deductible, so borrowing from a bank is preferable to using your retirement account.”
In short, you don’t want to worsen your financial situation down the road by rushing into things now. Best of luck!
