If you need cash for a down payment for a home, you might be wondering if you can use your 401(k) retirement plan funds.
Typically, when you withdraw funds from a 401(k) before age 59½, you incur a 10% penalty. This rule also applies if you withdrawn funds from your 401(k) for the purpose of buying a house. Therefore, a 401(k) withdrawal for a home purchase may not be best for some buyers.
However, there are two exceptions to this rule. The first is a 401(k) loan, which allows you to borrow from your 401(k) funds to buy a house. Since this counts as a loan to yourself, you don’t have to pay the early withdrawal penalty or income tax on the borrowed amount. The second is if you have a Roth 401(k): the contributions can be withdrawn early sans penalty and taxes, though the earnings cannot.
Learn more about the rules for using your 401(k) to buy a home and some alternatives for funding a home purchase, such as using a mortgage program or saving up cash.
Key Takeaways
- You can use 401(k) funds to buy a house by either taking a loan from or withdrawing money from the account. However, with a withdrawal, you will face a penalty and taxation on the amount if you are under age 59½.
- If you withdraw funds from a Roth 401(k) before age 59½, the contributions are not taxed or penalized, but the earnings are.
- A 401(k) loan must be repaid with interest, but you don’t have to pay income taxes or tax penalties.
401(k) Rules
A 401(k) plan is a tool that uses tax advantages to help you save for retirement. With a traditional 401(k), you can deduct your contributions from your taxable income to lower your tax bill for the year. Then, you pay taxes when you make withdrawals in retirement.
With a traditional 401(k), your access to these funds is limited. If you take money out early, you incur a 10% early withdrawal penalty. 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 55, if you’ve left or lost your job.
With a Roth 401(k), you make contributions with after-tax funds. Then you make withdrawals tax-free in retirement. And you have greater access to these funds compared to a traditional 401(k): you can withdraw the amount you contributed—though not what you earned—penalty- and tax-free before age 59½.
Loans and withdrawals are not just limited to home purchases, such as for a down payment for a home. You can also use the funds for second homes, home improvements, or to build a house.
401(k) Loans
The first option for using a 401(k) to purchase a home is borrowing from your account. You can borrow the lesser of either:
- $10,000 or half your vested account balance, whichever is more
- $50,000
When you take out a 401(k) loan, you do not incur the early withdrawal penalty, nor do you have to pay income tax on the amount you withdraw.
You have to repay the loan with interest, essentially paying yourself back. The interest rate and the other repayment terms are usually designated by your 401(k) plan provider or administrator. Generally, the maximum loan term is five years. However, if you take a loan to buy a principal residence, you may be able to pay it back over a longer period than five years.
Although the loan payments are returned to your 401(k), they don’t count as contributions, so you do not get a tax break nor an employer match on them. Your plan provider may not even let you make contributions to the 401(k) at all while you repay the loan.
401(k) Withdrawals
Not all plan providers allow 401(k) loans. If they don’t—or if you need more than a $50,000 loan—then you might consider an outright withdrawal from the account. With this strategy, you will incur a 10% penalty on the amount you withdraw from a traditional 401(k) unless you meet the requirements for an exemption.
Even with an exemption for a withdrawal from a traditional 401(k), you will still owe income taxes on the amount of the withdrawal. You can make outright withdrawals with penalties and taxation for any amount, and the withdrawn money does not have to be repaid. You can then replenish the 401(k) with new contributions deducted from your paycheck.
With a Roth 401(k), you can withdraw all your contributions with no taxes and penalties, but any earnings would be subject to taxation.
Downside of Using Your 401(k) to Buy a House
Tapping your retirement account for money for a house has drawbacks to consider, 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 even if you replace the funds, you have lost some potential for growth with the funds not being invested.
For example, if you have $20,000 in your account and take out $10,000 for a home, that remaining $10,000 could grow to $54,274 in 25 years with a 7% annualized return. But if you leave $20,000 in your 401(k) instead of using it for a home purchase, that $20,000 could grow to $108,548 in 25 years with the same 7% return.
With a Roth 401(k), you can withdraw the money you’ve contributed at any time tax- and penalty-free. However, if you withdraw earnings on your invested contributions before age 59½, you must pay taxes on them.
Alternatives to Using Your 401(k) for Buying a Home
Before you tap into retirement savings, consider all your options to determine which is right for you. For example, you may want to use funds from another account, like an individual retirement account (IRA), or delay home-buying until you can save up the cash you need.
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 IRA with no 10% penalty before age 59½ from an IRA if the money is used for a first-time home purchase. If you take a distribution larger than $10,000 from a traditional IRA, a 10% penalty would be applied to the additional distribution amount. It also would be added to your income taxes.
You can withdraw as much as you like from your contributions to a Roth IRA with no penalties and taxes, as those funds have already been taxed. However, if you want to withdraw earnings early from your Roth IRA, you must meet the five-year rule: You must have had the account forfive years, and you must also pay taxes on any earnings withdrawn.
Delay Homebuying
If you do not have enough cash to buy a new home, you may consider delaying your home-buying plans, if possible. That way, you can spend more time saving up cash for a down payment. The downside of delaying home-buying is the potential for home prices or interest rates to rise.
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.
United States Department of Agriculture (USDA) loans and VA loans offer 0% down payments. The minimum down payment on FHA loans is 3.5%.Meanwhile, conventional loans may require up to 20% down, although they may offer down payment options as low as 3% to first-time homebuyers.
Can You Use a 401(k) to Buy a House?
The short answer is yes, since it is your money. While there are no restrictions against using the funds in your account for anything you want, withdrawing funds from a 401(k) before age 59½ will incur a 10% early withdrawal penalty, as well as taxes. So, while it is possible to tap your 401(k) in lieu of a mortgage loan, it would end up being a very expensive source of funds, not to mention being disruptive to your retirement savings.
When Can You Withdraw From a 401(k) Without Penalty?
You can withdraw money from a 401(k) without paying a penalty in these situations:
- Medical debt that exceeds a certain percentage of your adjusted gross income
- A permanent disability
- A court-ordered withdrawal to pay a former spouse or dependent
- Active duty
- You owe the Internal Revenue Service (IRS)
- Death of the account holder
- Income after your official withdrawal age
How Much Can You Take Out of Your 401(k) to Buy a House Without Penalty?
You can take out a 401(k) loan for the lesser of half your vested balance or $10,000, whichever is more, or $50,000. You will incur interest that will be paid to your account, and you may not be able to make contributions until the loan is repaid.
How Much Can You Take Out of Your Individual Retirement Account (IRA) to Buy a Home?
First-time homebuyers or individuals who have not owed a home for at least two years are allowed to withdraw $10,000 from their IRA with no penalty. You can use that money to buy, build, or rebuild a home.
Can I Withdraw Money From My 401(k) to Buy a Second House?
You can withdraw money from a 401(k) to buy a second house, but you will incur an early withdrawal penalty of 10% as well as taxes.
The Bottom Line
The best use of 401(k) funds for a home would be to satisfy an immediate cash need, such as for an escrow account, down payment, closing costs, or whatever amount the lender requires to avoid paying for private mortgage insurance.
However, If you need to take a distribution from retirement savings, consider all of your options, including taking withdrawals from an IRA or delaying home-buying to save more cash. To use money in a traditional 401(k), you can take an outright withdrawal or a 401(k) loan. You can also withdraw contributions from a Roth 401(k) tax- and penalty-free, though not earnings. Which strategy is best for you will depend on a number of factors about your personal financial situation. Consider consulting with a financial advisor for guidance on your own situation.
