One of the challenges for first-time homebuyers is coming up with the funds to finance their purchase. One of the options that many look into is using their 401(k) for a down payment, but are hesitant to do so. If you’re looking to secure your purchase by using your 401(k), you need to explore everything there is to know about it – and we’re here to help you out.
A 401(k) is a retirement savings account that allows an individual to pull a portion of their salary (up to an annual limit) into long-term investments. When pulling from a 401(k) for the down payment, you may only have access to the vested amount, rather than the entire balance in the account. Why? This is because company matching funds may not be immediately available to choose from.
HOW DO I USE IT?
Before you withdraw funds from your 401(k), remember that tapping into it before you hit retirement age (59 ½ years old) will incur certain penalties. However, the hardship withdrawal option will allow you to withdraw $10,000 without incurring the 10% IRS penalty. Even if you qualify for this option, you still need to pay income tax on your withdrawal.
Unlike an IRA, which doesn’t require a rationale, a 401(k) relies on certain triggering events that need to be satisfied to receive some sort of payout from it. Some of these are when the buyer:
- Retires from or leaves their job
- Has passed away or is disabled
- Reaches the age of 59 ½
- Is subject under a specific hardship, or
- If the 401(k) plan itself has been canceled
The repayment terms are typically within 5 years, and are often taken out directly from your paycheck. The repayment period can be extended (up to 15 years) as long as the purpose of the loan is to purchase a primary residence. If you happen to have more than one 401(k) plan, you can utilize 50% of the vested 401(k) balances up to $50,000.
SHOULD I BORROW OR WITHDRAW?
At the end of the day, these are still your savings – and you’ve got the right to decide on how to use it. You can either borrow or withdraw from your 401(k) plan to purchase a house.
Applying for a 401(k) loan seems to be the more desirable option since you don’t incur the early withdrawal penalty, and you don’t have to pay income tax on the amount you receive.
Since it’s a loan, you will need to pay it back, or put money back into the account, including interest charges on the loan. The money you use to repay the loan will NOT be considered as contributions to your account. While you’re satisfying the repayment term, your 410(k) plan provider may not even allow you to make contributions to it at all until the loan is paid in full.
The only reason why you may be drawn to withdraw from your 401(k) is when your provider won’t allow you to apply for a loan, and you don’t have enough other funds to purchase the house. This is otherwise known as a hardship withdrawal. The challenge here is that buying a new home doesn’t necessarily count as a hardship. But in general, the IRS might allow the withdrawal of the money if it is urgently needed for a down payment on a primary residence.
With a withdrawal, you’re usually not limited to the amount you can take out. Not only that, the amount you withdraw doesn’t even need to be repaid. However, it’s still wise to replenish your account eventually with new contributions deducted from your paycheck.
WHAT ARE THE DRAWBACKS?
The biggest drawback is that you are using your retirement money. This is money you earmarked for retirement. By taking the money out to purchase a home, you are losing the years you took to save the money up. Whether you are paying back a 401(k) loan, or making up for a withdrawal, you will affect your current savings, and cash flow.
If you really need to tap into your retirement savings, you may want to consider that you cannot afford the house you’re looking to buy.
Admittedly, it can be tough to decide whether to use your retirement savings just to purchase a home. That’s why it’s advisable to consult real estate professionals before you do so. Strategy Properties realizes that a home is one of the single largest investment for an individual. The home buying process can be an emotional, and a grueling endeavor, especially for a first time home buyer. If you’re looking to buy your first primary residence, or are a new, or seasoned investor, call us at (734) 224-5454 or reach out to us via email at email@example.com.