Using retirement funds to buy a house will likely lead to penalties and a larger tax bill. It can also reduce your account's future earning potential.
One of the biggest challenges for first-time homebuyers is coming up with the money for a down payment. To overcome this obstacle, many people consider cashing out savings they have set aside in retirement accounts. But can you use retirement funds to buy a house, and if so, is it even a good idea?
Can You Use Retirement Funds to Buy a House?
The simple answer is yes; you can use savings from your retirement account to buy a home. However, doing so may cause you to incur penalties and a sizeable tax burden.
With most retirement accounts, you must be at least 59 ½ years old to withdraw funds without penalty. Individuals who cash out their retirement savings too early may find themselves on the hook for a 10% fee. You'll generally also be responsible for paying taxes on the amount withdrawn.
However, there are some ways to access the money in your retirement accounts with fewer (or no) added costs – especially for first-time home shoppers. Ultimately, though, this depends on the type of retirement account you have. We’ll go over the specifics regarding IRA, 401(k), and 403(b) plans.
Buying a Home With IRA Funds
Individual retirement accounts (IRAs) are a popular savings option among individuals who prefer to have more control over how their money is invested. But how much freedom do they offer when trying to use the funds to purchase a home?
Let's take a look at the rules for using an IRA for a down payment regarding both traditional and Roth accounts.
Traditional IRA
“First-time homebuyers considering using an IRA to fund their down payment can withdraw up to $10,000 penalty-free under the IRS first-time homebuyer exemption,” says Sal Dimicel Sr., real estate broker and owner of Lake Geneva Area Realty. “If married, both spouses can each withdraw $10,000, totaling $20,000 without penalty.”
For amounts over the $10,000 limit and for individuals who are not first-time homebuyers, there will be a 10% penalty. And as contributions to traditional IRAs are made with pre-tax income, you can expect to pay taxes on the full amount.
Roth IRA
Since Roth IRAs are funded with post-tax income, you can withdraw any of your contributed balance without penalty or tax burden. To freely withdraw earnings, however, you must be 59 ½ or older and have had your account for at least five years. Otherwise, you'll pay the 10% fee.
First-time homebuyers are permitted to withdraw up to $10,000 of the earnings in their Roth IRA without penalty. However, keep in mind that these funds will still be taxed.
Buying a Home With 401(k) Funds
A 401(k) is a workplace-sponsored retirement account with higher annual contribution limits than IRAs. In many cases, employers match a portion of the deposited funds.
Prospective homebuyers looking to use savings from their 401(k) plan have two options: a standard withdrawal or borrowing funds in the form of a loan.
401(k) Withdrawal
Cashing out funds from a 401(k) means paying taxes on the amount withdrawn. Plus, if you're under the age of 59 ½, you'll be responsible for the 10% penalty unless you are eligible for a hardship exemption. However, taking out the funds to purchase a home doesn't usually qualify.
Unlike IRAs, there is no first-time homebuyer withdrawal allowance with a 401(k) plan.
401(k) Loan
Another option for buyers with a 401(k) is to borrow from their savings. This can be a more practical strategy since there are no penalties or taxes on 401(k) loans. However, not all providers offer them, so be sure to check with your plan administrator or company's HR department.
When available, most 401(k) loans have terms of up to five years, although it may be possible to qualify for a more extended repayment schedule if you're using the funds to purchase your full-time home.
Interest costs on these loans are typically a percentage point or two above the prime rate. Still, since you're borrowing from your retirement savings, you're essentially making payments to yourself.
However, even if your plan permits you to borrow from your 401(k) balance, there are limits. Internal Revenue Code allows individuals to borrow the larger of $10,000 or 50% of their vested account balance, up to a maximum loan of $50,000.
For Example: If you have $15,000 of vested funds, you could borrow up to $10,000. If your balance is $50,000, you could borrow as much as $25,000. But if you have $150,000 in retirement savings, the largest loan you could take out would be capped at $50,000.
One thing to consider is that if you lose your job or decide to change employers, your loan will come due, and you'll only have a short time to repay the funds.
“Though initially tax-free, job changes trigger mandatory repayment, potentially leading to unexpected taxes and penalties from forced liquidation, as some clients experienced. Furthermore, these loans involve double taxation: repayment with after-tax dollars followed by taxable retirement distributions,” comments Seann Malloy, attorney and founder of Malloy Law Offices.
Can I Use My 403(b) to Buy a House?
403(b) retirement accounts are very similar to 401(k)s, with the primary difference being who offers them. While 401(k) plans are available through public sector employers, 403(b)s come from non-profits and government agencies.
The rules for using a 403(b) to buy a house are identical to a 401(k): you can withdraw the funds you need but will likely face a tax burden on that amount. Plus, borrowers under 59 ½ will encounter a 10% penalty.
Similarly, 403(b) loans are available through some plan providers, with limits being the greater of $10,000 or 50% of your vested balance, up to the $50,000 cap.
Is It a Good Idea to Pull From Retirement to Buy a House?
Your decision to use retirement funds will largely depend on your circumstances and funding needs, although most financial professionals recommend against it.
The reason? Retirement accounts are powerful savings tools because they harness the benefits of long-term compound interest. Withdrawing funds early to purchase a home means forgoing earnings, which can significantly impact the account’s future potential.
“The ‘opportunity cost’ is what most clients underestimate. I worked with a couple who withdrew $50,000 from their 401(k) for a down payment – this eliminated 20+ years of potential compound growth worth approximately $250,000 at retirement age. This financial setback was significantly more expensive than waiting another year to save traditionally," recalled Daniel Lopez, a loan officer at BrightBridge Realty Capital.
Paul Deloughery, an Arizona-based asset protection lawyer, offered another perspective to keep in mind. Accounts qualified under the Employee Retirement Income Security Act (ERISA) are largely protected from seizure in a bankruptcy.
“One crucial consideration often overlooked: retirement accounts offer exceptional asset protection. Federal law provides unlimited protection to ERISA-qualified plans and up to $1 million for IRAs in bankruptcy situations, with some states offering even more protection. Once you withdraw those funds for a down payment, you lose this valuable shield against potential creditors.”
How Do Early Withdrawal Penalties Work?
Since retirement accounts are designed to save for the future, the Internal Revenue Code dictates a 10% early withdrawal penalty for individuals under the age of 59 ½ who do not qualify for an exemption, such as financial hardship or the IRA first-time homebuyer allowance.
For example, if you’re withdrawing $20,000 from your 401(k), you can expect to pay a $2,000 penalty.
Plus, with the exception of Roth IRAs, contributions are made with pre-tax income, meaning you'll be responsible for paying taxes on however much you take out – even if you are exempt from the 10% penalty. These funds are treated as ordinary income – not capital gains – so you'll pay taxes based on your effective tax rate.
Using our previous example, a homebuyer with a combined federal and state tax rate of 24% would owe $4,800 on their $20,000 withdrawal. Together with the $2,000 penalty, they would effectively only receive $13,200, even though they would reduce their savings by $20,000.
Retirement Fund Tax Penalty Examples
Non-Roth Retirement Withdrawal | Roth Withdrawal | |
Retirement Funds | $20,000 | $20,000 |
10% Penalty | $2,000 | $2,000 |
24% Tax Rate | $4,800 | N/A |
Funds Received | $13,200 | $18,000 |
While retirement accounts can provide access to funds for a down payment, I strongly caution against this approach in most cases. I've seen clients who withdrew $30,000 from their 401(k) for a home purchase end up paying nearly $10,000 in taxes and penalties, while significantly damaging their long-term retirement outlook.
“While retirement accounts can provide access to funds for a down payment, I strongly caution against this approach in most cases. I've seen clients who withdrew $30,000 from their 401(k) for a home purchase end up paying nearly $10,000 in taxes and penalties, while significantly damaging their long-term retirement outlook,” says attorney, CPA, and former investment advisor David Fritch, owner of Fritch Law Office.
Down Payment and Closing Costs: How Much You’ll Really Need
Are you concerned about the downsides of using retirement funds to buy a house? The good news is that you may not need as much as you think.
Many first-time homebuyers assume they'll have to come up with a 20% down payment. That is little more than a myth. While there are advantages of putting 20% down, such as lower interest rates and elimination of mortgage insurance, the reality is that it's possible to get a loan with as little as 3%.
In some cases, borrowers may even be able to qualify with no down payment with the right mortgage program. We’ll go over those options a little further down.
So, how much would a first-time buyer need? With a $300,000 home, a 3%-down conventional mortgage would require just $9,000. With a 3.5% FHA loan, the down payment would increase only slightly to $10,500.
But this isn't the whole story. You'll also be responsible for closing costs, which could range anywhere from 2% to 6%, depending on the lender and type of loan you choose. Assuming estimated costs of 3%, this would be another $9,000, totaling $18,000 due at closing with a conventional mortgage for a $300,000 house.
One thing to keep in mind, however, is that you can negotiate many closing costs. Sometimes, lenders may be willing to cover them altogether in exchange for a slightly higher interest rate. Buyers looking to minimize their upfront expenses may also want to ask for seller concessions as part of their purchase agreement.
Other Down Payment Options to Consider
If you're struggling to come up with the down payment for your home purchase and aren't keen on cutting into your retirement savings, there are some other options left to consider.
Down Payment Assistance Programs
Down payment assistance (DPA) programs are typically offered through government agencies and non-profit organizations, as well as some employers and mortgage providers. Assistance may come in the form of grants, forgivable loans, or secondary liens (with or without monthly payments).
Eligibility requirements will vary by program, with many targeting first-time and lower-income homebuyers. You can find down payment assistance for both conventional and government-backed loans. While DPA is sometimes offered as a fixed dollar amount, you'll most commonly find programs providing between 3% and 5% of your contracted purchase price.
I just worked with a couple who nearly drained their 403(b) for a down payment, but we found a better solution through our state's housing assistance program instead.
“I just worked with a couple who nearly drained their 403(b) for a down payment, but we found a better solution through our state's housing assistance program instead,” states Sean Grabow, owner of Central City Solutions real estate investment group.
No- and Low-Down Payment Mortgage Options
As we mentioned earlier, buyers are often shocked to find out just how little they need to be able to purchase a home. While making the traditional 20% down payment has its advantages, plenty of no- and low-down payment mortgage options are available.
First-time homebuyers can get a conventional mortgage with as little as 3% down. The popular government-backed FHA program requires just 3.5%.
Qualifying service members and veterans can get a VA home loan without needing to make a down payment at all. Similarly, borrowers purchasing in designated rural communities may be eligible for a loan backed by the USDA, which also has the advantage of a 0% down payment.
Final Thoughts
While it is possible to use retirement funds to buy a house, most people will face penalties and tax consequences for doing so. Plus, cashing out savings means forgoing compound interest, which can impact your future earning potential.
In most cases, buyers would be better off considering alternatives such as low-down payment mortgages or locally available down payment assistance programs. However, your best course of action will likely depend on your financial goals and individual funding needs.
To see what options are available to you, talk with a qualified mortgage professional today.
