Can I Withdraw From My 401k to Purchase a Home?

If you don't own a home, then it's very likely your biggest asset is your retirement account. Putting away as much money as possible tax free for retirement is a good strategy that will pay off in the long run. But what if you want to buy a home, and the only money you have for a down payment sits in your 401k? There are ways to withdraw from your 401k to purchase a home.

Loan

A loan is the best option if you need money from your 401k to buy a home. The government allows you to borrow up to half your 401k balance, or $50,000, whichever is lower. Usually, the loan has to be paid back within five years, but the term can be extended to 10 or even 15 if the loan is to purchase a primary residence. The best thing about a 401k loan is you don't subject yourself to penalties or taxes as long as you pay it off within the specified time frame. You will be charged interest on the loan, but you pay it to yourself, instead of to a bank. One thing to keep in mind, though: If you leave your job or are fired before the loan is paid off, you will have to immediately pay off the balance or face taxes and penalties.

Hardship Withdrawal

Buying a home, making emergency repairs and staving off foreclosure are all reasons for which the government allows you to take a hardship withdrawal from your 401k. A hardship withdrawal is different from a loan in two ways: You don't have to pay the money back, but you will have to pay a 10 percent early withdrawal penalty if you aren't yet 591/2 and you will also have to pay income tax on the money.

Nonfinancial Hardship Withdrawal

If you meet a very narrow set of requirements, you may be able to withdraw money from your 401k penalty-free for a house or some other reason. Among the reasons a nonfinancial hardship withdrawal is allowed is if you are permanently disabled, your medical debts total at least 7.5 percent of your gross income or you quit, are laid off or retire early the same year you turn 55. Like other withdrawals, you are still responsible for the income taxes if you take this type of withdrawal.

Liquidation or Rollover

If you leave your job you can liquidate your 401k. Though this is not advised because of penalties and taxes, if you need the money for a home purchase, it might be something to consider. You can also do this if you have money sitting in a 401k from a previous employer. The better option, though, would be to roll the money over into an Individual Retirement Account. Unlike 401ks, IRAs have a provision that allow you to withdraw up to $10,000 penalty free for the purchase of a home if you haven't owned one for at least two years. You will still be responsible for income taxes on the money, though.

Considerations

Borrowing or withdrawing money from your 401k to buy a house affects you in many ways, mostly negative. Even if you are borrowing, you will lose the compounding ability of the money you took out. And if you take the money out during a down cycle in the markets, you could be hit even harder. Plus, the amount you pay yourself back is after-tax money, meaning you lose the tax savings on that portion of it. If you withdraw money, you automatically lose 10 percent of it, unless you meet age or other restrictions. And, depending on how much you withdraw, the amount could bump you into a higher tax bracket for one year, meaning you would pay even more taxes on the money.