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Can You Use Your Retirement to Buy a House?

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October 18, 2020

Can You Use Your Retirement to Buy a House?

If you are considering a home purchase, you might be wondering if you can use your retirement plan, your 401(k) or IRA to buy a house. The short answer is yes, but how might this affect your finances overall?

The 401(k). In return for giving you a deduction on the money contributed to a plan, and for letting that money grow tax-free, the government severely limits your access to the funds. You are not supposed to withdraw funds until you turn 59 ½ — or age 55 if you've left or lost your job. If neither is the case and you do take money out, you'll incur a 10% early withdrawal penalty on the sum withdrawn. Account holders will also owe regular income tax on the amount taken (as they would with any distribution from the account, whatever their age).

Still want to use your 401(k)? Your options are:

  1. Take a loan
  2. Withdraw the money
  3. Access other types of retirement accounts

The loan. When you take out a 401(k) loan, you do not incur the early withdrawal penalty, nor do you have to pay income tax on the amount you withdraw, but you do have to pay yourself back and to pay yourself interest. The interest rate and the other repayment terms are usually designated by your 401(k) plan provider/administrator. Typically, the maximum loan term is five years. However, if you take a loan to buy a principal residence, you may be able to pay it back over a longer period than five years. Check your plan's guidelines.

Keep in mind that although the repayments are being invested in your account, they don't count as contributions., i.e no tax break for you—no reduction of your taxable income. And of course, no employer match on the repayments. Some plan providers may not even let you make contributions to the 401(k) at all while you're repaying the loan.

Withdraw money. Technically called a hardship withdrawal, the IRS allows it if the money is urgently needed for, say, the down payment on a principal residence.

You are likely to incur a 10% penalty on the amount you withdraw unless you meet very stringent rules for an exemption. And you will still owe income taxes on the amount of the withdrawal.

You're only limited to the amount necessary to satisfy your financial need, and the withdrawn money does not have to be repaid. You can start replenishing the 401(k) with new contributions deducted from your paycheck. Ironically, borrowing from your 401(k) could affect your ability to qualify for a mortgage. Although you owe money to yourself, it still counts as debt in the eyes of a lender.

Other retirements accounts. Unlike 401(k)s, IRAs have special provisions for first-time homebuyers— according to the IRS, people who haven't owned a primary residence in the last two years.

First look to take a distribution from your Roth IRA, if you have one. You can withdraw your Roth IRA contributions if your plan allows distributions from accounts due to hardship. You can also withdraw up to $10,000 of earnings tax-free if the money is used for a first-time home purchase.

The next choice might be to take a distribution from a traditional IRA. As a first-time homebuyer, you can take a $10,000 distribution without owing the 10% tax penalty, although that $10,000 would be added to your federal and state income taxes. If you take a distribution larger than $10,000, remember that a 10% penalty would be applied to the additional distribution amount. It also would be added to your income taxes.

Now, here's a plus side to the year 2020: the CARES Act. This Act allows a distribution from a 401(k), 403(b), or IRA, regardless of age, up to $100,000 until December 31, 2020. The money can be used as needed, without penalty. There is certain criteria to meet, and keep in mind all distributions will be treated as taxable. Discuss with your Private CFO® the details of the CARES Act to determine if this option fits your particular financial situation.

The bottom line:

  • Best use of 401(k) funds for a home would be to satisfy an immediate cash need (e.g., earnest money for an escrow account, down payment, closing costs, or whatever amount the lender requires to avoid paying for private mortgage insurance)
  • Taking a loan from your plan could affect your ability to qualify for a mortgage. It counts as debt, even though you owe the money to yourself.
  • If you need to take a distribution from retirement savings, the first account you should target is a Roth IRA followed by a traditional IRA.
  • If those IRA's don't work, then opt for a loan from your 401(k).
  • The option of last resort would be to take a hardship distribution from your 401(k).

Contact your Private CFO® to determine if using your retirement plan to purchase a home is the best "move" for your financial future!

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About the author

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Micah Keel

Managing Director, Sarasota

Micah Keel is the managing director of oXYGen Financial in Sarasota, FL. Micah is an author, market analyst, and independent financial advisor with 20 years of experience in the financial services industry. He was honored with the Five Star Wealth Manager Award in 2014, 2015, 2016, 2017, 2018, 2019.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual.

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Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice.

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