Watch Out for Fees and Penalties
This is a common enough personal finance question, Jack, and as with everything, it’s really dependent on your personal situation. As a rule, though, raiding your retirement accounts should be your absolute last resort.
The key distinction that needs to be made regarding your question is whether you mean a withdrawal or a loan, according to Michael Ciccone, a New Jersey-based Certified Financial Planner. You could make a withdrawal, but that would likely come with a 10 percent penalty and you’d pay income taxes on the amount taken out (assuming it’s from a pre-tax retirement account like your 401(k)). It would also, obviously, hurt your retirement savings.
There is an exception for first-time homebuyers, which allows you to withdraw $10,000 penalty-free from an IRA for the purchase of your principal residence (you will pay income tax, though). If you have a spouse, you both could do this. And as long as you’ve had your Roth for five years, you can withdraw contributions tax- and penalty-free, too (just not earnings).
On the other hand, you might be able to take out a loan from your 401(k), which you’ll have to pay back over the next five years (though home buyers may secure an extension), with interest. If you do, you’re limited to borrowing the lesser of $50,000 or 50 percent of your vested account balance. Check with your HR rep to see if your plan allows it. (And note that if you leave your current employer, you might have to pay it all back at once, otherwise it turns into a withdrawal, which comes with taxes and penalties.)
But realize that it could severely hurt your retirement savings. Even though you’re repaying interest, that might not keep up with the rate of return you otherwise would have seen. The power of a retirement account, after all, is in the compound interest. And according to a Fidelity analysis, “a quarter of participants who take a loan reduce the amount they’re saving for retirement in their workplace savings plan, and 15 percent stop their contributions completely within five years of taking a loan.” Think about it: If you can’t afford a down payment without raiding your retirement account now, how will you make mortgage and insurance payments, and still save? It’s not going to magically work itself out.
“I wouldn’t advise anyone to utilize retirement money to help buy a house, unless perhaps you just needed a small amount to take you over 20 percent and avoid PMI, for example,” says Ciccone.
Rather than tapping your retirement fund, Ciccone suggests exploring other avenues, like:
- Finding a down payment assistance programs (many states have them)
- Asking a family member for a loan if possible
- Looking for a mortgage that doesn’t require a 20 percent down payment or paying the PMI
The last suggestion there is key. “Make sure that you don’t clean yourself out entirely in terms of cash to make your down payment,” says Ciccone. “Owning a home can be expensive and you never know when you might be hit with surprise repair bills or even other financial emergencies like large medical expenses or losing your job.”
It can seem daunting to put together 20 percent for a down payment, but the national average is much lower than that. I’d focus on building up your cash, even if it means delaying buying a home for a few more years.
“One would be better off starting by buying a smaller priced home than raiding retirement funds to make the initial purchase,” adds Mary McDougall, a Minneapolis-based Wealth Management Advisor for Merrill Lynch Wealth Management. “A mortgage usually carries the added benefit of having some of the interest classified as a tax deduction, so yes, borrowing from a bank would be better than your retirement account.”
In other words, you don’t want to make your money matters worse in the future by jumping the gun now. Good luck!
