Money Minute: Should I tap my 401(k) to buy my first home?
Yes, you can tap your IRA or 401(k) to cover a home purchase, but it's important to know the pros and cons first.
Making an IRA withdrawal
Typically, withdrawing funds from your IRA before age 59 1/2 can trigger a 10% penalty. But there's a key exeception for folks who are looking to buy a home: you can withdraw up to $10,000 for qualified home expenses penalty-free.
So long as you haven’t owned a principal residence in two years and you spend the money within 120 days, you're in the clear. And if you’re married, you can double your potential budget to $20,000. Just keep in mind you'll still owe income tax if you’re withdrawing funds from a traditional IRA. Roth IRA distributions are tax-free because you paid taxes on those upfront.
Before you decide to withdraw funds from either a traditional or Roth IRA for a home purchase, sit down with a tax advisor to be sure you won’t get slapped with a surprise tax bill.
Taking out a 401(k) loan
Another option to pay for a home is to take out a 401(k) loan. You can borrow up to 50% of your 401(k) balance, up to $50,000. You’ll pay yourself back, usually over a period of 5 years.
But before you get too excited about a 401(k) loan, know this: If you lose your job, it’s possible you'll owe the ENTIRE loan balance right away. And if you can’t pony up the cash, you’ll get hit with all the fees and taxes you initially avoided.
Not to mention, it can be tough to deal with a 401(k) loan when you’re already dealing with all the extra expenses that come with homeownership, including your new mortgage bill.
So...is it a good idea to tap your nest egg to pay for a new home?
In an ideal world, it is better to leave your retirement fund alone, says George Papadopoulos, a certified financial planner in Novi, Mich. “The best thing to do is save enough outside of accounts that are designed for retirement [so you don’t miss out on compounding interest],” he says.”
Mandi Woodruff is a reporter for Yahoo Finance and host of Brown Ambition, a weekly podcast about career, life and money.
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