401(k)s

Don't Tap Your 401(k) for a Down Payment

Withdrawing money from your retirement account to buy a house has several drawbacks.

We withdrew money from my husband's 401(k) plan so that we could come up with a down payment for a home. Now we're getting hit with the taxes on that money. Are there any exclusions of taxes on that income when the money is used for the purchase of a primary residence?

Sorry, but no. Even though you may be allowed to take a hardship withdrawal from a 401(k) to pay for a down payment on your main home, it isn't a good idea -- as you've discovered.

You have to pay taxes on the money at your top income-tax rate, plus a 10% early-withdrawal penalty if you're under age 59½. You can only withdraw your contributions and not any earnings or employer match, and you generally have to prove that you don't have another source for the cash.

You could have avoided the penalties and taxes -- at least for a while -- by borrowing the money from your 401(k) instead of withdrawing it. The specific rules vary by plan, but you may be able to borrow up to 50% of your vested account balance, with a maximum of $50,000.

You'll generally pay interest at the prime rate plus one or two percentage points, which goes back into your account. But there's a big downside to 401(k) loans: If you lose your job before age 55, you usually have to pay the loan back immediately, or get stuck with the same taxes and penalties that you'd have for withdrawals.

The rules aren't as harsh for IRAs. You can take up to $10,000 from a traditional IRA penalty-free to buy a first home (you can qualify as long as you haven't owned a house in the past two years). However, you still will owe taxes on the withdrawal.

A Roth is even more flexible: You can withdraw contributions from a Roth IRA for any reason without taxes or penalties, and you can withdraw up to $10,000 in earnings for a first-home purchase tax- and penalty-free if you've had a Roth for at least five years (you'll owe taxes, but not the 10% penalty, if you haven't had a Roth for five years).

Even if you can access any of this money for a down payment, it's generally better to search for other sources of cash -- and keep the funds growing in the account for your retirement.

For an update on down payment requirements and assistance, see An Open Door for First-Time Home Buyers. For more information about buying a home, see the Home Buyer's Survival Kit.

For more information about retirement-plan rules, see Why You Need a Roth IRA and Max Out Your 401(k).

Most Popular

Yes, You Can Collect Social Security from an Ex-Spouse: Here’s How
social security

Yes, You Can Collect Social Security from an Ex-Spouse: Here’s How

It’s always smart to maximize your Social Security benefits, and if you are divorced, one way to do that might be to take them based on your ex’s earn…
May 13, 2021
Refunds for $10,200 Unemployment Tax Break to Begin This Week
Coronavirus and Your Money

Refunds for $10,200 Unemployment Tax Break to Begin This Week

The IRS will start issuing automatic refunds in mid-May to people eligible for the unemployment benefit tax exemption.
May 14, 2021
18 Worst Things to Buy at Dollar Stores
spending

18 Worst Things to Buy at Dollar Stores

These discount retailers stock plenty of bargains, but some of the merchandise isn’t worth the buck.
May 14, 2021

Recommended

9 Tax Deadlines for May 17 (Tomorrow Isn't Just the Due Date for Your Tax Return)
tax deadline

9 Tax Deadlines for May 17 (Tomorrow Isn't Just the Due Date for Your Tax Return)

Between due dates for extension requests, IRA or HSA contributions, and other deadlines, there's more to do by tomorrow's tax deadline than just filin…
May 16, 2021
Saver's Credit: A Retirement Tax Break for the Middle Class
Tax Breaks

Saver's Credit: A Retirement Tax Break for the Middle Class

Your retirement contributions could be the key to a lower tax bill.
May 3, 2021
11 Places That Will Pay You to Live There
real estate

11 Places That Will Pay You to Live There

Working remotely? You may want to check out these places that'll pay you to move there.
April 23, 2021
12 Cheapest Small Towns in America 2021
real estate

12 Cheapest Small Towns in America 2021

Affordable small towns aren't necessarily the best places to live for everyone, but each cheap small town on our list has its charms.
April 15, 2021