In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses different options of how to use your 401(k) funds to buy your own house!
Are you thinking about purchasing a home? Don’t have the cash on hand for enough of a down payment? Did you know you can actually buy a house with your 401(k)? In this episode of Adam Talks, Adam Bergman will discuss the options you may have, depending on your retirement plan. No need to borrow funds from the bank or a family member. If you have been diligent with your retirement saving, you might be in luck to become a new homeowner.
How to Buy a House with Your 401(k)
Not many people know they may be able to use their retirement funds to help purchase a house. Buying a home is a life changing event. While you might not be able to afford to buy it outright, or don’t have enough cash on hand, you may have options. A lot depends on the type of plan you have, the rules of that plan and how much you have in it.
Keep in mind, unlike an IRA, you can’t always withdraw funds from your 401(k) or other workplace plan. Essentially, if you have a plan with your current employer, you usually can’t withdraw from the plan. You usually need a triggering event, such as leaving your job or the plan is terminated. Obviously, 401(k) funds are earmarked for retirement. Therefore, the IRS makes it harder to get access to those plans. There are ways though!
Loan Option
The first option is the 401(k) loan. Again, your plan must allow for it, and you should have enough funds in the plan. If you can borrow from your plan, you may take a loan of up to $50,000 or 50% of your account value whichever is less. You can use those funds for any purpose, whether it’s to pay off bills, buy a car, or, you got it, buy a house.
The terms of the 401(k) loan are pretty straight forward. Generally speaking, you have five years to pay off the loan, with payments due at least quarterly. The interest rate can be as low as the Prime Rate (which is 3.50% as of March 28, 2022), but may be a point or two higher. Still, much lower than a bank loan.
There is some risk to the loan option. If you fail to make a payment, or lose your job, the remaining balance of the loan will become due. It will be treated as a taxable distribution from the plan, and you may be subject to a 10% early withdrawal penalty if you are under age 59 1/2. You can choose to do multiple loans, but you cannot exceed the maximum allowed.
The best part is that you are paying the loan back, with interest, to yourself. It all goes back into your 401(k) plan. Of course, once the money is taken out of the plan, it ceases to enjoy the tax benefits of the retirement plan. It behooves you to get the money back in there as quickly as possible.
One other thing to consider is that if you do buy a house with a 401(k) loan, and it’s your principle residence, you can spread the loan over 15 years.
Hardship Distribution
A “hardship distribution” from a participant’s elective deferral account can only be made if the distribution is:
- because of an immediate and heavy financial need,
- limited to the amount necessary to satisfy that financial need, and
- limited to the participant’s total elective deferrals as of the date of distribution, reduced by the amount of previous distributions of elective deferrals.
Now, many plans allow for a “safe harbor” provision, which basically says you are deemed to have an “immediate and heavy financial need” if you are buying a principle residence. Remember, if you cannot satisfy the plan triggering events, the only way to withdraw current 401(k) plan funds is if you can qualify for a hardship distribution. Plus, you are not limited to the $50,000 loan cap.
Of course, if you withdraw funds like this, you will owe taxes on the amount you take. However, because of the provision, you will not owe a penalty if under age 59 1/2. This may be your only option if you are under that age and do not have a loan option available.
Of course, because of the taxes due, this is a far inferior choice to the loan option. That gives you tax- and penalty-free use of your funds and allows you to buy a house with your 401(k). Either way, removing funds from your retirement should be a last resort. The tax benefits are too great to pass up. However, if you really need those funds and buying a house is a dream, then, why not?
Bonus Option
Not 401(k)-related, but if you have an IRA, you have easier access to those funds. And, if you are under age 59 1/2, you can withdraw $10,000 from the plan, penalty-free as a first time home buyer. You are considered “first-time” if you haven’t owned a home in two years.
Keep in mind, this $10,000 is a lifetime amount. Once you’ve reached it, you cannot take a hardship distribution for a home purchase. Also, if your spouse qualifies, he or she can also take up to $10,000, essentially doubling the amount you can use.
Conclusion
Owning a home is many Americans’ dream. Due to circumstances, that may not always be possible for all of us. However, if you have saved for retirement, you have the option to buy a house with your 401(k) plan funds. It is best to speak with a financial planner to determine how this will affect your savings. Yes, retirement money is there for later in life, but why not spend it if you can have a better life?
As always, thanks for listening. Be sure to catch us on our SoundCloud page and check out this article for more information about the 401(k) loan. See you all next time!
