As I’ve written about extensively on the blog in the last few months, it has never been more difficult to join the ranks of homeownership in the United States than it is today. With interest rates still sky high, 30-year mortgage rates hovering around 7%, and home prices yet to materially drop in most areas of the country, it is hard to afford a home right now.
However, some prospective homeowners have turned to their retirement accounts as a way to afford a down payment and closing costs, in order to buy their dream homes more quickly.
But is this a good idea, or does the financial risk outweigh the potential reward? Today, I’m back to talk about whether it is ever okay to use your 401(k) or IRA in order to buy a house.
What is a 401(k)?
As a reminder, a 401(k) plan is an employer sponsored retirement savings plan offered to employees of businesses and companies nationwide. 401(k)s allow Americans nationwide to contribute and invest money for their retirement in the future.
In many instances, employers will actually match a certain percentage of employee contributions as an added incentive to get their employees to prepare for retirement. Today, there are two types of 401(k)s:
Traditional
Roth
Traditional 401(k)s
Traditional 401(k) plans allow employees to contribute money to their savings on a pre-tax basis. Essentially, these contributions can help you to lower your adjusted gross income (AGI), which will save you money come tax time.
As such, you won’t actually pay taxes on your contributions or investment growth until you withdraw your money, which can be done penalty free, starting at age 59 1/2.
Roth 401(k)s
Roth 401(k) contributions, on the other hand, are made on a post-tax basis. This means that you won’t receive any tax benefits now, though your contribution and investment earnings withdrawals will not be taxed, as long as you make qualifying withdrawals after age 59 1/2.
With either type of 401(k), withdrawing money before retirement, can lead to some pretty hefty tax penalties, so you will want to do everything you can to avoid this. also, while more and more employers are now offering Roth provisions for 401(k) plans, this is not yet a standard benefit in the industry.
401(k) contributions
Like many other tax-advantaged accounts, the United States Internal Revenue Service sets strict annual contribution limits to ensure that Americans don’t shelter all of their income from taxation.
In 2023, you can contribute up to $22,500 into your 401(k).
However, if you are 50 years of age or older, you’re eligible to make an additional $7,500 in catchup contributions, bringing you to a total limit of $30,000.
There is more good news, though. These figures do not include any employee match or profit-sharing plan that your employer may offer.
Typically, 401(k) contributions are made when you are paid, most often biweekly. Depending on who recordkeeps your employer’s 401(k) plan, you will likely have access to a website or mobile application that allows you to change your contribution levels, typically reflected as a percentage of your income.
Can you use a 401(k) to buy a house?
In theory, it is possible to use your 401(k) to help buy a home. There are two potential approaches as I see it, though both come with significant drawbacks. These two strategies include:
Taking a loan
Asking for a hardship withdrawal
1. Taking a 401(k) loan
The first potential approach would be to take a loan from your 401(k) account. Under normal circumstances, you will be limited to withdrawing the lesser of:
50% of your vested balance
$50,000
The problems with doing this, though, can be numerous. For example, it could force you to stay in your current job role, since leaving your company is likely to force an immediate pay back of the loan in full.
Otherwise, you likely will have five years to pay it back. Beyond the risk of taking your precious retirement savings, you also risk not being able to pay back your loan in full. And if this were to happen to you, your loan would be recorded as a distribution, which will lead to withdrawal penalties and potentially income taxes.
2. Hardship withdrawals
Your other option, albeit with lower chances of success, would be to take a hardship withdrawal. Many 401(k) plans on the market today have provisions within them that allow plan participants to access their funds in the event of an emergency.
There are two potential problems with this strategy:
Home purchases are unlikely to qualify as financial hardships
You will face are the withdrawal penalties and potentially income tax as well
I will go into more detail in a moment, but generally, I find it untenable to even consider using a 401(k) plan to buy a home, given the risks and roadblocks to doing so.
What is an IRA?
IRAs, short for Individual Retirement Accounts, are another retirement savings vehicle available to most Americans. The main difference between a 401(k) and an IRA is that IRAs are not employee sponsored.
This means that you can open an IRA on the side and contribute to it whenever you’d like. Similar to 401(k)s, IRAs, also come in traditional and Roth varieties.
And they work in the same way. Contributions into a Traditional IRA are done on a pre-tax basis, while Roth contributions are done on a post-tax basis.
Related: A first-time home buyer guide
IRA contributions
In 2023, you may save $6,500 in an IRA unless you were 50 years old earlier, in which case you can make an additional $1,000 catch-up contribution.
Similar to 401(k) plans, these rules are in effect to assure that the IRS is able to bring in sufficient tax revenue each year.
Can you use an IRA to buy a house?
IRAs can actually be used to buy a home, while at the same time helping you to avoid some of the negative consequences that using a 401(k) would cause.
If you have a Traditional IRA, you may be eligible to withdraw funds without penalty if you qualify as a first-time home buyer. Of course, the definition of a first-time homebuyer is set by IRS guidelines and requires you to not have owned a residence in the past 24 months.
Currently, you're able to withdraw up to $10,000 to use towards your home purchase in this way, though you will need to pay any applicable federal and state income taxes. You still have the option to withdraw more than $10,000, though these funds would then incur a 10% early withdrawal penalty.
Roth IRAs can also be used in special circumstances to buy a house.
Like traditional IRAs, you can access $10,000 from your account in order to buy a house. To be eligible, your Roth will need to have been open for a minimum of five years to avoid any taxes or penalties.
But you can also access a lot more cash than this, depending on the value of your account. One little known rule regarding Roth IRAs is that you can actually withdraw your contributions at any time, so long as you don't withdraw your investment earnings.
Whether it makes sense to do so is up for debate, but the rules are far more flexible than they are with 401(k) plans.
Should you use a 401(k) or IRA to buy a house?
Given the information I provided regarding the lack of flexibility that 401(k) plans offer for anything other than saving for retirement, I do not recommend touching any of these funds until you can make qualifying withdrawals come retirement time.
Your IRA, on the other hand, provides some additional flexibility. Still, in most instances, I do not believe that using retirement funds to buy a house is worth it, at least in our current environment. Here's why.
With home prices still sky high in most parts of the country and those stubbornly high mortgage rates still persistent, I'm not sure it makes sense to use retirement funds to buy a home near a likely top in the real estate market.
That said, I think there are two main variables that would help me decide whether or not I would use a retirement account to help me buy a home:
The interest rate environment
Home prices
1. Mortgage rate environment
I've already mentioned a couple of times how interest rates are really high at the moment, thanks to the Federal Reserve's fight against the inflation problem we've seen the past couple of years.
But if rates were to drop into historically low territory, anything around 5% or below, I would be a little more enthusiastic about using retirement money to buy and get into a house more quickly.
2. Home prices
Similarly, I'd be more likely to buy a home in part with money from my IRA if home prices were off cycle highs. My problem with doing so in the current environment is that there is not much value in the real estate market right now.
In fact, when combined with a high interest rate environment, people are now paying hundreds of dollars more per month to live in homes than they would have to buy similar homes just one year ago.
Alternatives to using your 401(k) or IRA
Now that you know that raiding your retirement accounts is unlikely to be your best option to make homeownership more attainable to you, I want to review a couple of other options that you do have to buy your house more quickly.
Other options you have include:
Pursuing first time home buyer programs in your state
Taking a specialty home loan from the FHA, VA, or other program
Conclusion
In theory, you can use your 401(k) and/or IRA to help you buy a house. And while I personally would never touch 401(k) dollars to do so, there are a couple of situations in which I would at least consider using some IRA dollars.
At the end of the day, though, I just don't love the idea. In practically all instances, the most financially responsible decision is to wait it out until you can afford a house without needing to touch retirement accounts.
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