Should You Ever Use Retirement Funds to Buy a House?
Retirement planning is important–there’s no debating that. Saving and investing in your 401(k) or IRA accounts is something all financial planners advise. However, for many people, allocating money to a retirement fund takes up a big chunk of a paycheck. If you’re maxing out your annual 401(k) and IRA contributions as you’re advised to do when possible, you might not have much money left over to fund other major milestones in life, like, for example, buying a home.
The 2010 limit for 401(k) contributions is $16,500 and the limit on IRAs is $5,000. That’s $1,350 and about $415 a month, respectively, of your gross income set aside just for retirement. As daunting as it may seem, financial planning for retirement shouldn’t be delayed or pushed aside unless there are very valid reasons.
In fact, some retirement plans allow you to withdraw or borrow funds from your accounts to help you financially if you need it, but you need to seriously contemplate the advantages and disadvantages of tapping into your retirement savings against using other options that are available to you.
Buying a House with 401(k)
Buying a house is part of the American dream, but so is a comfortable retirement. Fortunately, you might not have to choose between saving for one or the other. Many 401(k) plans allow you to borrow up to $50,000 or half of your retirement account, whichever is less, without a penalty. There are some advantages to borrowing against your 401(k), but also some disadvantages.
Pros:
- No credit checks
- You repay the loan amount and interest to yourself
- Save on private mortgage insurance
- Higher down payment available
- More favorable mortgage terms
Cons:
- Money is no longer tax-sheltered since repayments are 100 percent from take home pay
- Takes earning power away from your 401(k)
- You pay taxes on the interest you paid yourself during withdrawals
- Loan isn’t tax deductible like a traditional mortgage loan
- If you lose your job or quit, you have only 60 days to repay the balance of the loan
- Defaulting on the loan is considered an early withdrawal and subject to penalties and income tax
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You can borrow from your 401(k) for many reasons and aren’t limited to just a home purchase, but the point of a 401(k) account is to save for retirement, not to treat it like a credit card.
Buying a House with IRA
Though you can’t borrow money from your IRA like you can your 401(k), there are still some provisions that allow you to take out funds without suffering the 10 percent early withdrawal penalty if you’re under the age of 59 and a half.
You can withdraw as much as $10,000 from your IRA fund for certain instances like for educational expenses, some cases of financial hardship and a first home purchase.
Roth IRAs can be withdrawn without paying additional taxes since contributions are made after taxes anyway. Keep in mind that with Roth IRAs, you need to have held the account for at least five years before you make your early withdrawals on earnings from your contribution.
So money you added yourself is safe to withdraw, but money earned from your contributions could be taxed if you haven’t held the account for at least five years. Also, keep in mind that you only have 120 days to use the withdrawn funds to purchase your home, so plan accordingly.
While some IRAs allow you to invest in real estate through your account, the property cannot be used as a personal residence. The IRS has very strict rules in how you go about investing in rental properties, but that’s another topic for another time.
Is Tapping Your Retirement for a Home a Good Idea?
Most experts would advise against using your retirement funds to help with purchasing a home. The reason is because you’re taking earning power away from your accounts and you’re limiting your safety net to support you in old age. In addition, you run the risk of spreading yourself too thin accessing retirement funds to take on a mortgage you maybe can’t afford.
What’s more, if you’re tapping your Roth IRA account for funds, the contribution limits remain the same, so you can’t just catch up over time. If your income exceeds the limit for Roth IRAs in the near future, then you’re out of luck, too.
For practical purposes, owning a home helps you develop equity in your residence, which could eventually be used to help fund your retirement if you choose to do so. Consider it a way to diversify your investments.
You can also enjoy tax benefits when you sell your primary residence–the IRS allows you to exclude up to $250,000 of gains ($500,000 if filing jointly) on the sale of your home–that could outweigh the disadvantages of tapping into your 401(k) or IRA.
It’s a serious decision to make, so be sure to consult a professional financial advisor and gather as much information available before pulling the trigger.
Does tapping your retirement for a home purchase sound like a good idea strategy to you?
