It’s no secret that purchasing a home will most likely be the costliest transaction that many individuals will make, with several first-time buyers struggling to obtain the funds needed to secure the required down payment and closing costs.
Several potential buyers consider the option of borrowing from their 401(k) to cover the initial deposit – but this will have an effect on your retirement fund over time. Two options are available in this regard – doing a withdrawal or taking out a loan, and the pros and cons of each option will be discussed below.
The main benefit of obtaining a loan from your 401(k) is that you’ll be able to get the funds you need and not have to worry about paying an early withdrawal penalty or income tax on the funds that have been withdrawn. Although money borrowed will have to be repaid with interest, you’ll be paying yourself back and contributing to your retirement at the same time.
Unfortunately, not all 401(k) funds provide the option of loaning money from your savings, and if your fund does allow this, you’re limited to the amount that can be borrowed. Your limit will normally be half of its invested value or a maximum of $50,000 – whichever amount is lower.
Any loan from your 401(k) will usually need to be repaid within five years, with interest. Some employers may also prevent you from making new contributions to your account during this time, and this will stop your retirement funds from growing as they should. Stopping these contributions can also place you in a higher tax bracket.
The main advantage here is that you won’t have to stress about repaying the amount you’ve withdrawn, and funds can be used however you like. The amount you withdraw in this way is also not limited, unlike when taking a loan.
Some employers don’t allow withdrawals to be made, and may require what is called a hardship withdrawal that will allow you to access your 401(k) funds before you turn 59½. The IRS will normally permit this if funds are being used as down payment on a primary residence.
You’ll also technically be taxed twice if making a withdrawal because it will count as income, and if you’re under 59½, an additional 10% early withdrawal penalty will need to be paid as well.
If taking a loan or withdrawal from your 401(k) is not an option for you, some other alternatives are available:
- Withdrawing funds from your IRA
- Obtaining a personal loan
- Requesting a cash gift from friends or family
- Using a down payment assistance program
Although borrowing or withdrawing from your 401(k) is usually possible, it’s not normally the best option. If you would like to find out more about how you can finance a home purchase, get in touch with our team today. We look forward to helping you to make your dream of home ownership come true.