A 2020 TC Ameritrade report found that most Americans want to retire by the age of 67, using a 401(k) plans as their vehicle of doing so.
To help ensure your golden years are financially stable, it’s critical to plan in advance with a retirement savings plan. If you are one of the people saving for retirement but need money for a down payment, should you borrow against retirement to buy a home?
Let’s breakdown the factors that affect your decision.
What is a Retirement Savings Plan?
Simply put, a retirement savings plan is money that is set aside to be spent after retirement. Which means if you plan to withdraw it earlier, you’ll pay a penalty, along with the taxes you owe given your current tax bracket.
There are many different ways to set aside this money, and you’ll put yourself in the best financial situation if you start planning for retirement sooner rather than later.
However, there are times where you may need to borrow from your retirement in order to purchase a home. Depending on your retirement plan, there are some accounts that are more favorable than others.
Different Types of Retirement Savings Plans
Here are some of the most common retirement savings plans that are used today.
Retirement plans offered through your place of employment. You can contribute a portion of your paycheck to your retirement and some employers will match your contribution (up to 6%). Contribution limits are more generous than other plans topping at $19,500.
Individual Retirement Accounts (IRAs)
These are investment accounts (stocks, bonds, mutual funds, etc.) where you typically make investment decisions yourself. These are additional options to 401(k) plans, and you can contribute up to $6,000 a year. You can buy and sell investments, but if money is taken out too early (59 and ½ years old) you will be penalized.
Roth IRA contributions are made with after-tax dollars – but that is the only time they are taxed! You can withdraw before retirement without penalties, as long as it’s five year past your first contribution.
Features of both a Roth IRA and 401(k) are combined and offered through employers. There’s no income limit and the same limitations apply as the other accounts.
Much like a 401(k), this is a retirement plan offered by small businesses up to 100 employees.
Self-employed? This account allows you to continue a portion of your income to your own retirement account. Annual contributions are higher at $58,000 or 25% of your income.
How to Borrow Retirement Plan Savings to Buy a Home
Borrowing from your 401(k) might be beneficial long-term—and could help your overall finances.
You can use 401(k) funds to purchase a home, either by taking a loan from the account or by withdrawing money from the account.
401(k) loans don’t require a credit check, and don’t show up as debt on your credit report. However, not all employers offer 401(k) loans as an option in their retirement plans. However, if this is a road you choose to take, remember that even if you are laid off or leave your current job, you are still required to pay the loan. If either of those happen, the loan must be repaid in full by the next tax filing date.
A second (less desirable) option is to make a direct withdrawal from you 401(k). If the withdrawal does not classify as a hardship, or emergency removal, then you’ll incur at least a 10% early withdrawal penalty. Withdrawals from Roth IRAs are generally preferable to taking money from a 401(k).
Pros to Borrowing from a Retirement Plan to buy a home
- You could pay interest to yourself
- You may avoid paying PMI
- A house is a smart investment
Cons to Borrowing from a Retirement Plan to buy a home
- You must be disciplined to pay yourself back
- Having to pay penalties, fees, and interest (sometimes at a higher interest rate) depending on the specifics of your company’s 401(k)
- Losing out on the compounding interest
- Missing out on your company’s match
Should You Borrow Against Retirement for a Home Purchase?
Can you borrow against your 401k for a down payment on a house? The simple answer is yes. However, it may not be the best, or only, solution. There are other alternatives such as down payment assistance programs and first-time home buyer loans such as FHA loans, USDA loan, and other state and regional loans.