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Using a 401(k) to Buy a House: What You Need to Know About Protecting Your Retirement

Using a 401(k) to Buy a House: What You Need to Know About Protecting Your Retirement

Saving up enough money to buy a house isn’t easy, especially if you only have one income for the household or live in a major market. You will need a minimum of 20% of the purchase price as a down payment to avoid having to pay for mortgage insurance. That’s $80,000 on a $400,000 house! It could take many years to save that much cash. Besides, who would want to wait that long if there was a way to begin offsetting most of the cost of additional taxes the first year in your new home?

You may have heard about the possibility of using a 401(k) to buy a house, but maybe you didn’t give it any serious consideration. After all, doesn’t it go against traditional financial advice to even touch your 401(k) before your 60s? This may be the prevailing logic, but more and more individuals are finding that there is more flexibility than they previously thought when it comes to financing crucial life milestones with the help of a retirement fund.

Paying rent may be convenient but it’s never cheap

Apartments are expensive because mortgage interest is a tax-deductible expense. Rental payments don’t provide any avenue of tax relief for the renter, not to mention the lost opportunity to gain wealth through equity growth from investing. It takes time, effort, and budgeting to gather enough cash for a down payment on a home, but you can use some of your retirement savings to help make the dream happen sooner. Yes, there is a cost for using a 401(k) to buy a house; however, properly planned, you can control that expense and any potential impact on your credit. The cycle of paying rent can be a difficult one to get out of, but the sooner you are able to invest in your own property and begin growing your own equity, the better for a healthy financial future.

What are my non-cash options for a down payment?

If this will be your first home, you can withdraw up to $10,000 from your Roth IRA, Traditional IRA, SEP IRA, or SIMPLE IRA without paying a penalty. Since Roth IRA contributions are post-tax, no income tax is due. However, making a withdrawal of any amount from your 401(k) will be taxed as regular income for the year and 10% penalty will be applied in addition to that. 

401(k) loans are not considered a taxable transaction; therefore, they aren’t subject to a penalty either. This can become tricky, though, because the first loan repayment is due immediately and will show on your mortgage application. And, you would then be responsible for a new mortgage and loan payments. Be wary of involving a large loan with a new mortgage note, as this could cause financial stress if not properly planned out. It’s very important to sit down with an experienced financial advisor who can help you navigate the ins and outs of your portfolio and help you make the best decision about whether or not to leverage your retirement funds in a home purchase.

How to use IRAs to your advantage

Changing jobs isn’t a bad time to use money from your retirement account to buy a home. Once you leave the company, you can rollover your 401(k) into an IRA and then withdraw from it to avoid the penalty. If you have a still have a retirement account with a former employer, you can make a withdrawal from it whenever you choose. However, you will need to roll over the account into an IRA first if you’re using a 401(k) to buy a house. There is some work involved to get the transfer completed, so plan well in advance before making a bid on a house. In this scenario, you will pay regular income tax and do not need to repay yourself. Again, mortgage interest is tax-deductible so you get to recapture the tax expenses for retirement savings being reclassified as income by the IRS.

Finding the best approach to home-buying 

As you see, there are a few different approaches that can put you closer to homeownership if you take the right approach. Seeking the help of a tax planning pro to provide a bit of advice on liquidating part of your retirement account is the first important step. The timing of the transaction is important to maximize the long-term benefit of such an important decision. You don’t need to feel reluctant or frightful for using a 401k to buy a house. 

If you are ready to finally be free of paying rent for someone else’s property, the advisors at SD Mayer can help. Finding a home is challenging enough. Let us help you take some of the stress away from signing for a home mortgage. You can move forward with confidence, knowing that you have taken the right steps for you and your family. Contact us today for more information.

Image Credit | Watchara Ritjan | Shutterstock

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