Is it a good idea to borrow from your 401(k) or IRA to buy a house? What to know

Homeownership is one of the most popular ways that Americans build wealth over time, and retirement accounts are up there as well.

The two investment areas might seem unrelated, but in many ways they are connected, especially as most people must make choices in terms of how to divvy up their investment dollars.

Few individuals can quickly save up for a downpayment, along with other home-purchase closing costs, while also diverting a lot of money into a workplace 401(k) plan or some type of Individual Retirement Account.

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The downpayment dilemma

Saving for a downpayment can be a struggle, especially for prospective first-time buyers. Sometimes, it can make sense to pull money out of retirement accounts for this purpose to get that first foot in the homeownership door. Is there a way to do this optimally?

“While the conventional wisdom says you should leave your retirement funds untouched, homeownership might be difficult to achieve without dipping into your retirement accounts,” wrote Bankrate.com analyst Jeff Ostrowski, in a recent commentary. “If you feel strongly about homeownership or you think of rent payments as wasted money, it might make sense to forgo some future retirement savings to buy a home now.”

Some 9% of homeowners surveyed by Bankrate said they tapped into their retirement savings to buy their dwelling. Younger homeowners were twice as likely, with 16% of those between the ages of 18 and 27 doing so, compared to 8% of Americans ages 60 and up.

Just keep in mind that penalties and taxes might apply from early withdrawals from either a 401(k) or traditional IRA.

Plus, you could forsake investment gains if the stock or bond markets rally while your money is off doing other things. The reverse also could hold true, meaning you could sidestep a big drop, but the stock market usually is rising more often than it's falling.

Which type of withdrawals work best?

If you plan to pull money from a retirement account, a few key rules could guide your thinking.

Straight withdrawals before age 59 1/2 usually are a bad idea, as a 10% penalty generally would apply along with ordinary taxes on the amount taken. But many workplace 401(k) plans allow you to borrow against your balance with no penalties or taxes, assuming you repay the amounts on schedule.

If you own a Roth IRA, you may withdraw an amount equal to your contributions, what you invested, without taxes at any age. However, withdrawals that reflect gains or earnings might be taxable if you're under 59 1/2 and haven't held the account at least five years. Beyond those limits, all withdrawals would be free of taxes and penalties.

With traditional IRAs, taxes and the 10% penalty typically apply on withdrawals made before 59 1/2, but there's an exception that's relevant to down payments.

“The IRS allows you to withdraw up to $10,000 without penalties for a first-time home purchase," which in this case means you haven't owned a home in the prior two years, Ostrowski wrote. “However, you’ll still have to pay income tax on the amount withdrawn if you’re pulling from a traditional IRA.” That $10,000 figure is a lifetime amount, not one tied to each home purchase.

On 401(k) accounts, there’s arguably a better option: Depending on your plan's rules, you might be able to borrow up to $50,000 from your account. You would need to repay what you borrowed, plus interest, back into your account, but you could avoid taxes and penalties by doing so, he noted.

Many people don't rely on just one resource to scrape together the funds for a downpayment.

For example, Bankrate found that 41% of current homeowners saved specifically for that goal, while 14% relied on gifts from family members or friends. First-time homebuyers sometimes can qualify for loan-assistance programs, as was cited by 14% of respondents in the survey. A fairly modest 9% relied on withdrawals or loans from retirement accounts.

The rationale for renting

The American homeownership rate has risen modestly over the past decade and currently stands near 66%, though that's below the peak of 69% in 2004. That means a good chunk of the population is content to rent, either by choice or necessity. High home prices and mortgage interest rates aren't making it easier to buy dwellings.

In fact, 37% of renters responding recently to a NerdWallet survey said they are planning to rent forever. For some of these people, it's a lifestyle choice.

Aspects that support renting, as cited in the report, include the significant downpayment and closing-cost hurdles to buy a home, not feeling so tied down to a certain area by renting, fewer maintenance responsibilities for renters and a sense that homeownership might not represent a sound investment.

While pulling money from retirement accounts can be a source of downpayment funds, it also could emerge as a source of regret later.

Some 21% of American adults surveyed by Bankrate said getting a late start on retirement savings was their top financial regret, ahead of other choices including taking on too much credit card debt (15%) and not building up an emergency fund (14%).

Reach the writer at russ.wiles@arizonarepublic.com.

This article originally appeared on Arizona Republic: Buy a home or save for retirement? When it makes sense to pull funds