Can I Use My 401(K) to Buy a House?

You would typically incur a 10% early withdrawal tax or penalty if you withdraw funds from a 401(k) before age 59½. This rule also applies if you withdraw funds from your 401(k) to buy a house, so taking money for a 401(k) withdrawal for a home purchase may not be the best option for some buyers.

However, there are two exceptions to this rule. The first is to take a 401(k) loan, which allows you to borrow funds from your 401(k) to buy a house. This counts as a loan to yourself, so you don’t have to pay the early withdrawal penalty or income tax on the borrowed amount. Another exception exists if you have a Roth 401(k). Your contributions can be withdrawn early from this type of account without penalty and taxes, although the earnings are taxed.

401(k) Rules

A 401(k) plan is an investment account that helps individuals save for retirement with some tax advantages. However, it’s important to note that these advantages differ depending on whether you save in a traditional or a Roth 401(k) plan.

Your access to these funds is limited with a traditional 401(k). You’ll incur a 10% early withdrawal penalty if you take the money out early. Account holders will also owe income tax on the amount. The earliest you can withdraw from a 401(k) without facing penalties is age 59½ or age 55 if you’ve left or lost your job.

Contributions to a Roth 401(k) are made with after-tax funds. You can’t claim a tax deduction for the money you invest in the year you contribute it. You can then take withdrawals tax-free in retirement; however, you have greater access to these funds compared to a traditional 401(k). You can withdraw the amount you contributed penalty- and tax-free before age 59½, although not the account’s earnings.

401(k) Loans

The first option for using a 401(k) to purchase a home is borrowing from your account. However, you must check to see if your plan permits you to borrow from the account. If it does allow loans, individuals may borrow up to 50% of their vested account balance, or up to $50,000, whichever is less.

You won’t incur the early withdrawal penalty, nor do you have to pay income tax on the amount you borrow from the account if you take out a 401(k) loan. However, you have to repay the loan with interest, but there is a silver lining: the interest you pay on the loan goes back to the 401(k) account. The interest rate and the other repayment terms are usually designated by your 401(k) plan provider or administrator. The maximum loan term is generally five years.

However, if you borrow the money to buy a principal residence, you may be able to pay the loan back over a period longer than five years.

The loan payments are returned to your 401(k), but they don’t count as contributions, so you don’t get a tax break or an employer match on them. Your plan provider may not let you make contributions to the 401(k) while you repay the loan.

401(k) Withdrawals

Not all plan providers allow 401(k) loans. You might consider an outright withdrawal from the account if yours doesn’t or if you want to borrow more than $50,000. You’ll incur the 10% penalty on the amount you withdraw from a traditional 401(k) in this case, unless you meet the requirements for an exemption.

You’ll still owe income taxes on the amount of the withdrawal from a traditional 401(k), even if you qualify for an exemption. You can make outright withdrawals with penalties and taxation for any amount, and the withdrawn money doesn’t have to be repaid. You can then replenish the 401(k) with new contributions going forward.

You can withdraw all your contributions with no taxes and penalties from a Roth 401(k) but any earnings would be subject to taxation.

Downside of Using Your 401(k) to Buy a Home

Tapping into your retirement account for money for a house has its drawbacks, whether you take outright withdrawals or a loan. The main downside is that you diminish your retirement savings. Not only does your total retirement account balance drop but you have lost some potential for growth with the funds not being invested for a while even if you replace the funds.

Let’s say you have $20,000 in your account and you take out $10,000 for a home. That remaining $10,000 could grow to $54,274 in 25 years with a 7% annualized return. The $20,000 could have grown to $108,548 in 25 years with the same 7% return if you had left the $20,000 in your 401(k) rather than using it for a home purchase.

Alternatives to Using Your 401(k) to Buy a Home

Consider all your options to determine what’s right for you before you tap into your retirement savings. You might want to use funds from another account, such as an individual retirement account (IRA), or delay buying a home until you can save up the cash you’ll need.

Individual Retirement Accounts (IRAs)

Individual retirement accounts (IRAs) have special provisions for first-time homebuyers and people who haven’t owned a primary residence in the last two years. You can withdraw up to $10,000 from a traditional or Roth IRA with no 10% penalty before age 59½ from an IRA if the money is used for a first-time home purchase.

The 10% penalty would be applied to the additional distribution amount if you take a distribution larger than $10,000 from a traditional IRA. You’d also have to pay income tax on the amount.

You can withdraw as much of your contributions to a Roth IRA with no penalties and taxes because those funds have already been taxed at the time you made the contributions. However, you must meet the five-year rule if you want to withdraw Roth IRA earnings early. You must have held the account for five years, be disabled, or have reached age 59½. You must also pay taxes on any earnings that are withdrawn.

Mortgage Programs

Homebuyers can use homeownership programs offered by the federal government to encourage homeownership, such as Federal Housing Administration (FHA) and U.S. Department of Veterans Affairs (VA) loans. These programs offer lower down payments and have less stringent credit requirements. For example, United States Department of Agriculture (USDA) loans and VA loans offer 0% down payments. The minimum down payment on FHA loans is 3.5%, which can be helpful, as conventional loans can require up to 20% down.

The Bottom Line

The best use of 401(k) funds for a home would be to satisfy an immediate cash need, such as an escrow account, down payment, closing costs, or whatever amount the lender requires to avoid paying for private mortgage insurance.

Consider all your options, however, before you take a distribution from retirement savings, including taking withdrawals from an IRA or delaying home-buying to save more cash. You can take an outright withdrawal or a 401(k) loan if you want to use the money in a traditional 401(k). You can also withdraw contributions from a Roth 401(k) tax-free and penalty-free although this doesn’t apply to earnings.

Your best strategy will depend on several factors about your financial situation. Consider consulting with a financial advisor for personal guidance.