A lot of my friends are buying houses right now, and I have a lot of questions for them. I usually start off by asking the non-intrusive questions, like why they've decided to say goodbye to renting or how they landed on the house of their dreams. Then, I ask the burning question I just need to know — how are they affording the down payment.
A friend recently told me she withdrew half the cash in her 401(k) to put towards her down payment. I had always been warned, for so many years by so many people, not to touch the money in your retirement fund (unless it's a true emergency). I had heard about potential taxes, penalties, and just the overall setback you'd face by pulling out cash too early. I wondered if what she was doing was a good idea or something others should consider avoiding.
So I asked the experts and learned why financial planners and advisors say taking cash out of your 401(k) to pay for a house is not such a good idea.
While you might look at the balance of your 401(k) and think you can take out some of the cash and use it however you'd like, that's not necessarily the case.
There's an option to borrow money from your 401(k) tax-free if you pay back the loan on time (typically within five years). If you're using the money to buy a primary residence, you may have more time to pay back the loan, but that depends on your plan administrator.
But if you take the money out and do not pay it back, you may incur taxes.
If you fail to pay back your loan on time, you may incur a 10% tax penalty (if you are under 59 1/2). You will also have to pay income tax on the withdrawal.
It might be your goal to buy that house right now, but tapping into your retirement fund to make it happen might take you away from your future financial goals, experts say.
"By tapping even a small portion of your retirement nest egg early, you run the risk of derailing the progress you have made in saving for retirement in addition to the penalties and taxes incurred," says Kenny Senour, a financial planner. "It's true that you can begin to replenish the money you take out through your future paycheck deferrals, but it can take a long time to rebuild depending on how much is taken out."
Financial advisor Jenna Lofton says you may also lose out on compound interest if you pull out a large chunk of your savings and take years to pay it back.
"If there was ever an investment where
compound interest
works in your favor, this is certainly one," says Lofton. "These accounts are designed to have you living as comfortably post-retirement as you can envision yourself doing during pre-retirement."
Some might justify tapping into their 401(k) as a way of getting just a few more dollars to afford that down payment, but according to Steve Landersman, a financial planner, what they don't realize is that they aren't prepared for so many other costs.
"The main reason I'm opposed to people tapping into their IRA or 401(k) plans for a home purchase is that it shows they don't have the reserve savings necessary to be a homeowner," says Landersman. "Just buying the house is the first step, there are always unexpected expenses and improvements."