One of the most common questions we receive about 401k plans is ‘can I use my 401k to buy a house?’ If you have a sum saved in your 401k it may seem like the obvious place for you to obtain the downpayment you need to buy a property.
While it is possible to use your 401k to buy a house, there can be significant downsides to this course of action. Keep reading to find out everything you need to know about using your 401k to buy a house.
Making a 401k hardship withdrawal
401k plans are intended for retirement savings. So, if you want to take money out of your 401k plan early, there are penalties and taxes in place to deter you.
Congress did make provision in the 401k plan rules to allow you to access their savings in extreme circumstances. However, the rules don’t allow you to take money simply because you’re inconvenienced. You have to prove you need the money for a certain purpose such as paying funeral expenses or buying a main residence.
In addition, if you are younger than 59 ½, any money that you withdraw from your 401k to buy a house is subject to the appropriate income taxes. You will also pay a 10 per cent ‘early withdrawal penalty’.
Keep in mind also that your employer does not have to offer the ability to make a hardship withdrawal. You should therefore check that such a withdrawal is available to you.
A 401k loan
An alternative to making a 401k hardship withdrawal to buy a house is to consider a 401k loan.
Most 401k loans are agreed regardless of your needs and it can be very easy to obtain a loan against your retirement plan. When you borrow from your 401k plan you also benefit from the interest that you pay. This is because the interest that you pay goes back into your 401k plan. For example, if you borrow $4,000 and pay back $4,750 in total, the extra $750 goes into your plan.
However, there are also disadvantages of borrowing from your 401k to buy a house. You may have to pay fees for the loan and you will be foregoing some funds from benefiting from tax deferred growth.
In addition, if you default on your 401k loan payment it is treated as a distribution. This means that your money is taxed and you have to pay the 10 per cent early withdrawal penalty if you are aged under 59.5.
Using your 401k to buy a house
In summary, the answer to the question ‘can I use my 401k to buy a house’, the answer is ‘yes’. However, for the reasons mentioned above the costs may not be worth it. You may be better considering other options such as borrowing money from friends of family or delaying your house purchase until you can save up more of a downpayment.