401K WITHDRAWAL HOME PURCHASE: Should You Use Your 401K to Buy a House?

401k withdrawal home purchase
Image Credit: Money Crashers

Becoming a homeowner in the state is something everyone looks forward to. If you’d achieve this with a mortgage, then you need to worry about your down-payment. Although there are conventional loans such as FHA and the development loan for houses in rural areas, most mortgage providers will demand at least a 20% down payment. Considering the cost of homes presently, it may be difficult to process. As a result, some people resolve to withdraw from their 401k accounts. While it definitely will serve when you do not have the money to cover your down payment, this comes with a lot of disadvantages. We will highlight these as well as the penalty for the first 401K withdrawal home purchase. Additionally, we provide other alternatives that you can use in place of making a one-time or maximum withdrawal on a 401k account for a home purchase.

What Is a 401K Account?

The 401k is a retirement plan account offered by an employer to his employees. It is a saving and investment account designed to help you save for retirement. Employees put a certain amount of their income into the account as savings. Unfortunately, it does not generate interest as a normal savings account should. Interest can only be accumulated when holders of these accounts invest their 401(k) funds in securities such as bonds, stocks, REITs,  ETFs, and so on. The main purpose of the account is to plan for retirement. To access the fund in this account, you must be at least 59 and half years old or  55 with no active job. Anything less than that is called an early withdrawal. demands you pay a penalty for it. 

Benefits of the 401K Account

The 401k account has three distinct benefits. These are;

  1. The income put into a 401(k) is tax-free.
  2. Any profits made on your 401(k) investments are also tax-free.
  3. Employers may your match contributions in part or whole.

Limitations of the 401K Retirement Account

The limitation of the 401k retirement account was placed as a penalty by the government to limit early withdrawal on the 401k account. There are two limitations to this account, these are;

  • There is a 10% withdrawal fee on early withdrawal on your 401k.
  • Your 401k withdrawal amount is subject to tax. The tax is in addition to the fee. 

Can I Use My 401K Withdrawal for a Home Purchase?

Well, you can but we’d rather you don’t. Now before you scream the account is mine for crying out loud, what the heck do you mean by that? Relax, take a deep breath and calm down. The account is yours, and you are free to do whatever you want with it. Unfortunately, using your first 401k withdrawal on a home purchase may not be a decision you’d be proud of in the future. This is because it will tell on your retirement, especially when you do not have other retirement plans. So we’d suggest you source for other alternatives such as a money gift or go for a loan that permits about a 3.5% down payment.  Examples of loans with about 3.5% down payment demand are conventional loans such as the FHA loans and so on.

Additionally, If you receive a monetary gift and it is less than 60 days before your mortgage application, Business yield advises you to get a gift letter to convince your mortgage provider you didn’t collect a loan from someone to make a down payment. These are other alternatives you can use in place of making withdrawals from your 401k account for a home purchase.

401K Loan vs 401k Withdrawal for Home Purchase

A 401k loan allows you to take money out of your retirement account and repay it over time with interest. Let’s simply say you borrowed money from your account but will have to repay the principal with interest into your account.  While the 401k withdrawal permanently removes funds from your retirement savings for immediate use, such as home purchase but you will be subject to additional taxes and penalties. Especially if you are yet to meet the IRS rule for retirement.  So if you must touch your 401k account for home purchase, consider taking out a loan and not withdrawing.

Maximum 401K Withdrawal Home Purchase

Making a withdrawal from your 401k retirement account before actual retirement is known as a hardship withdrawal.  According to the IRS, an emergency withdrawal of assets from a 401(k) to satisfy “an immediate and substantial financial necessity” is known as a hardship withdrawal. While I wouldn’t advise anyone to make a maximum withdrawal from a 401k account I hope you don’t use your 401k account for a home purchase either. However, since you are allowed to take out a hardship withdrawal, you can meet your employer if it is the last resort that is open to you. Your employer will decide if purchasing a home passes as a hardship withdrawal. If he is convinced, you can go ahead and make the necessary withdrawal needed for your home purchase down payment from your 401 accounts. 

Penalty 401k Withdrawal Home Purchase

The 401k account is structured in a way that if you must make a withdrawal, you have to be up to 55 years with no active job or 59 and half years. Therefore any 401k withdrawal not in line with these rules comes with a penalty whether it is for a home purchase or not. Remember, the account is untaxed income saved towards your retirement, this means you are not supposed to withdraw before retirement. Although there are several reasons why someone will make a hardship withdrawal, the penalty remains the same. 

What Is the Penalty for 401K Withdrawal Home Purchase?

If you’d make a withdrawal from your 401k for a home purchase or other purposes, the law demands to get approval from your employer. This is because withdrawing before the set age is a hardship withdrawal and it is your employer who decides whether the situation passes for hardship or not, and thereafter comes the penalty.

There are two penalties that early withdrawal brings.

  1. The first penalty for early 401k withdrawal for home purchase purposes is that there is a 10% withdrawal fee on the account.
  2. Since it is an income account, the withdrawn amount will be subject to tax.

 For instance, if you’d be making a $20,000 withdrawal from your 401k account for a home purchase, you will pay a $2000  penalty fee for early withdrawal. You will also pay income tax on the remaining $18,000. If you fall under the 12% rate, you will pay 12% of the $18,000. This means you will pay about $3240. And at the end of the day, you will only get about $14,760 out of your $20,000 withdrawal. So rather than make a withdrawal from your 401k account for a home purchase, outsource your down payment to avoid penalty.

How to Avoid 401K Withdrawal Home Purchase

There are other considerations that one can take rather than reduce your retirement savings for a home purchase. The following are a few examples;

#1. Request for a Money Gift

Requesting for a money gift to make up your home purchase down payment is far a greater option than making a 401k withdrawal. If you have families, friends, and acquaintances that will help, do not hesitate to contact them. However, make sure you get a gift letter from them. The gift letter specifies who made the money gift as well as their contact information. It also includes the purpose of the monetary gift and has the giver’s signature. It convinces your mortgage provider you did not borrow to offset your down payment.

#2. Emergency Funds

Life generally teaches us to have money plans for unforeseen and future expenses. That is one of the reasons why we hold money. Also, financial experts always advise we save for emergencies. You can also check out the ETFs that offer yield too just to boost your emergency fund. Your emergency will be very useful than making a withdrawal from your 401k account.

#3. Use Of IRA

First-time homebuyers are privileged with IRA because there is a provision for them. It allows first-time buyers to withdraw up to $10,000 without paying the 10% early withdrawal penalty if they haven’t owned a primary residence in the last two years. However, you will still pay tax on the income. However, penalty-free does not mean tax-free. You will still pay tax on the money.

#4. Federal and State Government First-Time Home Buyer Programs

You can also use the state and federal government fist time homebuyer scheme instead of making a maximum or one-time withdrawal from your 401k account for a home purchase. This includes the FHA loan and others. The FHA loan requires just a 3.5% of downpayment and a credit score of at least 580.

401K Withdrawal for Other Purposes Aside From a Home Purchase

If you intend to withdraw for other purposes, aside from a home purchase, then you check the following options

#1. 401k Loan

Taking out a 401k loan simply means you will pay back the money you are taking out of your 401k account with interest.

#2. Personal Loan

You can also consider taking out a personal loan in place of making a 401k withdrawal. Lenders wouldn’t come after your asset in the case of default. This is because a personal loan is not backed by assets, however, it is relatively difficult to secure.

#3. Portfolio Credit Loan

Compared to other types of loans, portfolio credit loans have low-interest rates. This is major because it is a collateral-backed loan. 

4. Maximize Credit Card Offer

You can also take advantage of an introductory credit card. Most often, it offers 0% interest for a set period. This may help you meet your immediate spending demands. While you make plans to handle your debt before the promo term is over.
 

One-Time 401k Withdrawal Home Purchase

The one-time 401k withdrawal home purchase simply means you withdrew all your IRS savings at once. Well, if you are already 59 and half years or 55 years without a job, it wouldn’t be an issue. But if you are less than that, it isn’t such a good decision. Making a one-time withdrawal from your 401k account may be ideal for senior citizens, however, using it for a home purchase, means you have emptied your retirement account. Also, you will make installment payments monthly to your mortgage providers for your home purchase, how do you intend to do that when you did a one-time withdrawal from 401k? it really will be difficult except you have other financial support from elsewhere.

Conclusion

Should I use my 401k withdrawal for a home purchase? Business yield experts will outrightly say No, however, if it is the only available option you have, then you can go ahead. Just ensure you have exhausted other means of raising your down payment. Remember, making a maximum withdrawal from 401k just for a home purchase may affect your future financial need if you do to have other retirement savings. Alternately, you can opt to take out a 401k loan rather than a withdrawal.

FAQs On 401k Withdrawal Home Purchase

What Constitutes a 401(k) Hardship Withdrawal?

A hardship withdrawal is a condition that makes one withdraw from their 401k account before age 55 or 59 and a half. Generally, hardship withdrawals, which are exempt from the 10% penalty, can be made for a variety of reasons. Examples of conditions that pass for hardship withdrawal include medical bills, tuition, fees associated with purchasing or repairing a primary dwelling, funeral expenses, and so on.

If I take out a 401k loan, who gets the interest paymentsI will pay?

A 401k loan, literally means you are borrowing from yourself. When you pay back the money, you do so with interest you will also get the interest.  However, you will still have to pay tax on the income. 

What happens when someone default on a 401(k) loan?

Defaulting a 401k loan simply means it will be considered an early withdrawal. However, you can check your company’s rules on your 401k account to know exactly what to do. But generally, you’ll owe all the penalties and income taxes you’d owe on an early 401(k) withdrawal.

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