For many families, their 401(k) or other retirement plan is their biggest, most important asset. So it’s very natural to wonder if you can use your 401(k) to help make a down payment on a house.
The answer is a qualified “yes.” It is possible to use a 401(k) plan to help with purchasing a home, though if you are still working for the company, your plan rules have to allow for something called an “in-service withdrawal.”
If You Still Work for the Company
If you are still actively working for the plan sponsor and your plan rules allow for in-service withdrawals, all you have to do is notify your human resources department or your plan administrator that you want to take a distribution to put toward the down payment of a home. Some plans also have a separate set of emergency or hardship distribution rules that allow you to access your 401(k) balance in the event of an “immediate and heavy need.” Some plans include the purchase of a personal residence as such an event. This may also enable you to access your 401(k) balance for the purchase of a down payment on a personal residence.
If you can qualify for the withdrawal under the emergency distribution rules, that’s even better, since that may enable you to sidestep the 10 percent penalty that usually applies to distributions prior to age 59½. (The 10 percent penalty is also waived if you are age 55 or older and you have left the service of your employer.)
If You Have Left the Company
If you have left the company, you can also take a distribution, paying income tax and – depending on your age, a possible 10 percent penalty. (To avoid the penalty, you may want to conduct a 401(k) to IRA rollover first. This may help because there are no penalties on up to $10,000 in distributions for the purpose of putting a down payment on a first home if you take the distribution from an IRA.)
Advantages and Disadvantages
The advantage to using a 401(k) to help with a down payment is obvious: You can get that money now, and save yourself from having to rent for months or years while you save up for a down payment.
You should also be aware of a number of downsides, though:
- The 401(k) plan provider will withhold 20 percent of your withdrawal to pay income taxes with. So you won’t see your entire distribution – only 80 percent of it.
- You’ll have to pay income taxes. Since you didn’t pay income taxes on your contribution, you’ll have to pay them in the year of the withdrawal. The plan administrator will send you and the IRS a Form 1099.
- You are unplugging a tax-deferred vehicle. However, your home also grows tax-deferred, and the first $250,000 in gains are tax exempt. For married couples, you have up to $500,000 of gains exempt from capital gains taxes when you eventually sell the home.
- 401(k)s receive unlimited protection from creditors under federal law. Home equity may not have the same protection, depending on your state.
Some plans let you borrow from your 401(k), rather than make a withdrawal. This lets you tap the funds in your 401(k) with no taxes or penalties. You just have to pay yourself back with interest. But since you are paying the interest to yourself, this isn’t a big deal.
Normally, the most you can borrow from a 401(k) is $50,000, or half the plan balance, whichever is less. This is usually enough for a down payment on a primary residence for most of us, though. Also, most 401(k) loans must be paid back over five years – normally via payroll deduction. So your employer will take your repayment out of every paycheck until the balance is paid off. Some plans, however, let you extend the repayment period to 10 or 15 years for loans to help buy a personal residence.
Use caution, though: If you lose your job, or leave your employer, you normally have just 60 days to pay off the loan. Otherwise, the IRS deems it a distribution, and the rules above apply.
Not every plan allows for 401(k) loans, so check with your human resources department for the rules specific to your plan.