Using 401(k) for House Down Payment

Oct 31, 2023 By Susan Kelly

Using the funds from your 401(k) to pay for the down payment for an existing house is typically permissible. There are some advantages: 401(k) loans aren't tax-deductible and have low-interest rates. However, borrowing money through your 401(k) can cause serious and permanent harm to your pension savings. It's therefore not suggested as a source for a down payment. If you're considering using the funds from your 401(k) to purchase a home, you should consider the low or no-down-payment mortgages on the market currently. Many people can purchase houses for just three percent or less, or even 0 more than 1% down. So, there's a chance that you do not need to draw from your retirement savings to invest.

How Does It Work

You can take an amount of money out of the funds in your 401(k) account up to $50,000, or half of the account's total value, whichever is lower. You'll have to pay interest on the funds that you borrow, but you won't be required to pay taxes or penalties for this amount if you repay the loan in time. The cost of the interest? It's returned to the 401(k) savings account. The time you'll need to repay the loan will depend on your specific plan. Certain plans may provide you with five years to repay your loan. This is done with regular monthly installments similar to the auto or mortgage.

There are always complications. If you must leave your work sooner than you expected and you are required to repay the rest of the loan in 60-90 days. If you aren't able to do this and your loan is not paid back, it will be considered an early withdrawal. This means you'll need to pay taxes and penalties on any amount you are still owed. If you can afford the monthly payments and are not yet retired, taking advantage of your 401(k) might be a good option for down money for your payment.

Withdrawing from a 401(k)

The most basic and least beneficial method is to withdraw the funds completely. This is a violation of the rules for withdrawals from hardships, which have been recently made more straightforward, allowing account holders to take out their contributions and contributions from their employers. The cost of buying a home for "principal residence" is one of the legal reasons to take a hardship withdrawal from the 401(k). Suppose you decide to withdraw funds but do not pay the entire income tax on these funds, just as you would if it were a different regular income for that year. This is especially unappealing when you're in an upper tax bracket because the cash withdrawal is an additional tax on top of your regular income. There is a penalty of 10% tax, also referred to as an early withdrawal fee, in addition to that when you are younger than 59 1/2.

Borrowing from a 401(k)

Another option is to take a loan from your 401(k). You can borrow up to $50,000 or the amount of half of the account or less, provided you're purchasing a home. It is much better than taking the money out for various reasons. In the first place, even though you pay an interest rate on a loan, the rate is typically 2 points higher than that of the rate at which you earn. But you're paying interest to yourself more than the bank. It also means you're earning a small amount of money from your money.

Repayment Window

The drawback is that you must repay the loan and the repayment period usually is no longer than five years. For a loan of $50,000, this is $833 per month, plus interest. You have to disclose this information to the bank when seeking a loan as it could impact your monthly costs. Before the Tax Cuts and Jobs Act of 2017, if your job ended before the loan repayment, you were typically given a 60-90-day window to pay the entire balance. In 2018 the tax overhaul extended the repayment period until the due date for your federal income tax return and allowed extensions to file. If you fail to pay back the loan within that timeframe triggers regular taxation, as well as the penalty of 10% tax since the remaining amount is deemed an untimely withdrawal.

Another Downside

Another issue is that borrowing money from your 401(k) can mean that you miss out on the investment potential of these funds. Additionally, certain 401(k) plans won't let contributions until you've completed the loan repayment. Although your 401(k) is a simple source of money for a down payment, it's best to save the money elsewhere and not borrow or take the cash in the future. If you must use the money, it's more beneficial to borrow them rather than to withdraw them and be unable to access these tax-advantaged savings for the rest of your life.

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