Should You Raid a Retirement Account to Buy a Home?
Is the home worth your retirement savings? This is the question that the reader has been puzzling over this week.
Every Monday, we address one of your pressing personal finance questions by seeking advice from several financial experts. If you have a general question or money issue, or just want to talk about something PeFi-related, leave it in the comments or email me at [email protected].
This week’s question comes from Jack:
Is it wise to give up your retirement savings in order to buy a home? This includes a 401 (k), Roth IRA and pension. Are there any withdrawal penalties? Are there any withdrawal restrictions? Is this a better option than borrowing from a bank? This is my first time buying a house.
This is what individual experts usually say about a problem that affects each person differently: if you need personalized advice, you should see a financial planner.
Beware of fees and fines
This is a fairly common personal finance question, Jack, and like everything else, it really depends on your personal situation. However, as a rule of thumb, robbing your retirement accounts should be the most last resort.
According to Michael Ciccone, a certified financial planner based in New Jersey, the key distinction to be made regarding your question is whether you are referring to a withdrawal or a loan. You can withdraw money, but this will most likely incur a 10 percent penalty and you will be subject to income tax on the amount withdrawn (assuming it is from a pre-tax retirement account such as your 401 (k)) … It will also obviously hurt your retirement savings.
There is a first-time homebuyer exemption that allows you to rent $ 10,000 without the IRA penalty on your primary residence (however, you will pay income tax). If you have a spouse, you can both do this. And if you have your Roth for five years, you can withdraw contributions without taxes and penalties (just not on earnings).
Alternatively, you could take a loan from your 401 (k) that you have to pay back over the next five years (although home buyers can provide an extension ) with interest. If you do, you can borrow less than $ 50,000, or 50 percent of your legal account balance. Check with your HR representative to see if your plan allows it. (And note that if you quit your current employer, you may have to pay it all out at once, or it will turn into a waiver, which entails taxes and fines.)
But remember, this can seriously hurt your retirement savings. Even if you pay interest, it may not match the rate of return that you would otherwise see. After all, the strength of a retirement account lies in compound interest. And according to Fidelity’s analysis , “a quarter of borrowers cut the amount they save for retirement in their workplace savings plan, and 15 percent stop paying altogether within five years of receiving the loan.” Think about it: If you can’t afford a down payment without raiding your retirement account now, how will you make your mortgage and insurance payments while keeping your savings? It won’t magically work.
“I would not advise anyone to use retirement money to buy a home unless, for example, you just need a small amount to bail out more than 20 percent and avoid PMI ,” says Ciccone.
Instead of using his retirement fund, Ciccone suggests exploring other possibilities, such as:
- Finding Down Payment Assistance Programs (many states have them )
- If possible, ask for a loan from a family member
- Looking for a mortgage that doesn’t require a 20 percent down payment or PMI payment
The last sentence is key. “Make sure you don’t completely clear yourself out in cash for the down payment,” says Ciccone. “Owning a home can be costly and you never know when you will face unexpected repair bills or even other financial emergencies such as high medical expenses or job loss.”
It may seem like a daunting task to add 20 percent for the down payment, but the national average is much lower . I would focus on hoarding your money, even if that means delaying your home purchase for a few more years.
“It would be better to start by buying a home at a lower price than raiding retirement funds to make the initial purchase,” adds Mary McDougall, wealth management advisor for Merrill Lynch Wealth Management in Minneapolis. “Mortgages usually provide the added benefit that some of the interest is classified as a tax deduction, so yes, a bank loan is better than your retirement account.”
In other words, you don’t want to make your money worse in the future by jumping off your gun now. Good luck!