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Asked 4/3/2007

Why not take money out of 401k for 1st home???

People are telling advising different things to me and I just wanted to see what you all thought.

Why would it be a bad idea to withdrawal all of my money from my 401k to buy my first house? I look at it like this.. instead of money in a 401k retirement fund, I've invested the money into a home in which I can live in while at the same time still gain appreciation on the value.

By doing so, it would lower my monthly mortgage considerably and I would have more cash flow in which I could fund the 401k from the ground up again.

Why is this such a bad idea?

Or if you agree it's a good idea, please let me know why you think so as well.

Thanks!
I just wanted to add that there is a exemption in the 401k that allows you withdrawal money at no penalty for a first home purchase. The only thing I will be paying is taxes, no penalties. Does that change anyone's opinions?
Ok, I called Fidelity and you guys are right. There are NO exemptions that allow you to take money out of a 401k to buy a home, penalty free.

However, my plan does allow you to borrow up to 7,500. Not much so to me it's not worth it.

BUT... since I'm starting a new job next week, I do have the option to roll over my 401k into the IRA. And from the IRA, I can with withdraw (penalty free) for first home purchase.

Does that change anyone's advice?
Wanted to add that if I were to borrow money from the 401k, I would have to pay interest back on repayment... BUT, the interest paid would go into my account so essentially I'm paying myself.

 
 
 
 
 
 
Answers

Answer 1/9 - Submitted 4/3/2007

It is a bad idea becuase in addition to the taxes that you will pay on the withdrawal, you will also have to pay a 10% penalty on the early withdrawal. So whatever you have in your 401(k), you can figure that you could only get about 50% of it after taxes and penalties. That is a very expensive source of funds. Borrowing from the bank, where you even get a tax deduction on the interest that you pay is a much less expensive way to get money.

***Edit***
There is no exemption for a first time homebuyer to withdraw money from a 401(k). This is what the IRS website has to say:

"Can I withdraw funds penalty free from my 401(k) plan to purchase my first home?

If you are under the age of 59 1/2, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a 10 percent additional tax on early distributions from qualified retirement plans. However, depending on the rules for your 401(k) plan, you may be able to borrow money from your 401(k) plan to purchase your first home. Your plan administrator should have written information about your particular plan that explains when you can borrow funds from your 401(k) plan as well as other plan rules.


References:

Publication 575, Pension and Annuity Income
Publication 560, Retirement Plans for Small Business
Tax Topic 424, 401(k) Plans
Tax Topic 558, Tax on Early Distributions From Retirement Plans"

 
 

Answer 2/9 - Submitted 4/3/2007

I agree with BosCFA. Also, by taking your money out of your 401k, you are losing the interest you would be earning by leaving it there.

While it may seem like it will make things easier now, think about how much easier it would make your retirement to have that money plus the interest it will accrue later in your life.

 
 

Answer 3/9 - Submitted 4/3/2007

Being a mortgage broker I never tell a customer to take money from a 401K plan. First, you are depleting your savings for retirement, second, in some 401K plans you are paying interest on that money just the same as if you borrowed the money, and well, lets face it, it is taken out of your pay which gives you less cash flow, just the opposite of what you thought. Next you must consider that your 401K is an asset the same as your home would be. Youd be taking one asset to pay another asset which is actually a loss because you have no interest earning on the 401K plan. The more you have in your plan, the more you make in earnings for that quarter and eventually a year or more. At the same time your home is appreciating at a rate of about 3% per year so you have gains in both your assets not including the interest you are able to deduct from your taxes because of interest paid on your home, plus deductions on the homestead act you get whenever you buy a home. Also, when you finance your home, or go to refinance your home banks love to see reserves. Reserves are those items such as savings accounts, 401Ks, stocks, etc. This tells them that if you were to lose your job or whatever how many months could you make your payments before you couldnt make them any more. The more reserves you have the better you are. Also, and last but not least, a mortgage can significantly help your credit score. If course, if you dont make your payments on time it can hurt them as well.

 
 

Answer 4/9 - Submitted 4/3/2007

When you take money out of a 401(k) before age 59.5, you will instantly flush away about half of it to taxes and penalties. That is money that will no longer be growing tax-deferred at an average (typically) of 10% a year until you retire. Long-term, property has never grown that fast in value, so fundamentally you would be flushing 50% of what you have saved down the toilet so that you can invest the rest in a property that will grow in value more slowly than what you had.

Does that really seem like a smart move?

I hope not!

A better way might be to only buy as much house as you could afford to make 1.5 to 2 times the principal payments on. (Each month your payment is $1000, say, about $800 of that is interest at the beginning, and $200 is principal....If you paid $800 interest and $400 principal, the amount you owe on would come down twice as fast, and you will own the house in considerably less than half the time!)

Just do all the math...it's only numbers!

Good luck...

 
 

Answer 5/9 - Submitted 4/4/2007

whoever told you there was an exemption was wrong. the exemption is for IRA's and not 401k's.

If you can buy the house without the 401k, why not have both? Run the numbers and see exactly how much you'd lower the payment. But realize this...housing appreciates at 6-7% a year and the market appreciates at 11-12% a year. And if you need money when the housing market is down...you're SOL. If you need money when market is down...you can sell only a small piece of your holdings.

 
 

Answer 6/9 - Submitted 4/4/2007

I suppose it depends on how badly you need the money for the down payment. You will have to pay normal taxes on the money withdrawn. I believe there is a limit of $10,000 on what you can withdraw (which will add $3,000 to your tax bill for that year). There is nothing wrong with it, but given the additional taxes it may not be the cheap source of money you think.

 
 

Answer 7/9 - Submitted 4/4/2007

I don't think there is an exemption for taking money out of a 401k for a first home--that's only in IRAs.

Also, even if there is an exemption, it's probably only for 10,000 (the limit to take out of an IRA for a home). A $10,000 downpayment is not going to affect your monthly payments very much at all. Run the numbers. You may pay $15 or $20 less per month with $10,000 downpayment than you would with none.

If you take money out of your 401k to put into home equity, your net worth will DROP. You'll pay taxes (around 25% gone right there) and probably penalties on top of that (even if you're right about the exemption you'll pay penalties on any amount over $10,000 you withdraw). So say you have $50,000 in your 401k. If you take it all out, you'll have only about $32,000 in cash to put toward your downpayment. Plus you'll probably spend a chunk of it on closing costs and furniture and moving costs. So you'll have a small downpayment and NO retirement savings.

Plus, you need savings! You will never accumulate any wealth if you drain your savings accounts every time you really need/want something. You might have a house, but in retirement you're going to need money for food, medicine, and electricity.

Additionally, right now would be about the worst time to borrow money to buy a house because values may not be going up for awhile--they might even go down in certain areas. Plus the stock market is not doing well, so you'll be selling low (not a good strategy in case you didn't know). Sell stocks low to buy real estate high??? Not a good idea!

 
 

Answer 8/9 - Submitted 4/10/2007

Well it sounds all good but you have nothing for retirement and you get taxed heavy for taking it out before 59 1/2.
You have to find out if the tax you will get hit with is worth it in the long run. Don't let a short term solution become a long terk mistake.

 
 

Answer 9/9 - Submitted 4/10/2007

I will bet that you could earn more on your house then you could with the interest on your 401k plus any fees for withdrawl. I earned 55k on my house in year 1 on a 12,000 investment. I still live in it and didn't flip it. I took the 55 out and made even more. Just depends on what you are really trying to do.

 
 
 
 

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