Borrowing From Your Retirement Plan
You can borrow from your 401(k) to buy a primary residence through a 401(k) loan, provided your plan sponsor allows it. This is generally considered a better option than an outright withdrawal because you avoid immediate taxes and the 10% early withdrawal penalty.
401(k) Loan Details
A 401(k) loan is essentially borrowing money from yourself. The interest you pay on the loan goes back into your own account.
Maximum Amount: You can generally borrow up to 50% of your vested account balance, or $50,000, whichever is less.
Repayment Terms: The loan must typically be repaid within five years, but many plans allow for an extended repayment period (up to 10 or 15 years) if the funds are used for the purchase of a primary residence.
Tax Implications: As long as you follow the repayment schedule, the loan amount is not considered a taxable distribution, and you won't incur the 10% early withdrawal penalty.
Job Change Risk: If you leave your job (voluntarily or involuntarily) before the loan is fully repaid, the outstanding balance usually becomes due in full by your tax filing deadline. If you can't repay it, the balance is treated as a taxable withdrawal, subject to both income taxes and the 10% penalty (if you are under age 59½).
Missed Growth: The primary drawback is that the money you borrow is no longer invested and growing within your retirement account, which can have a significant long-term impact on your retirement savings potential.
Alternatives to Consider
Financial experts generally recommend exploring other financing options before tapping into your retirement savings.
Traditional or Roth IRA Withdrawal: You may be able to withdraw up to $10,000 in a lifetime from an IRA without the 10% early withdrawal penalty if you are a first-time homebuyer. You will still owe income tax on traditional IRA withdrawals, but Roth IRA contributions can be withdrawn tax-free and penalty-free at any time.
Low-Down-Payment Loans: Look into government-backed programs like FHA loans (minimum 3.5% down payment) or VA loans (no down payment for eligible veterans) that make homeownership more accessible.
Down Payment Assistance Programs: Check with your state or local housing authority for programs that offer grants or low-interest loans to first-time homebuyers.
Consult with a financial advisor and your plan administrator to understand the specific rules of your 401(k) plan and the best option for your financial situation
Disclaimer: This is not accounting or legal advice. Everyone’s financial position is specific to them. Check with your CPA and other professionals for the best advice.
