Want to buy a house but you’re short on cash?
If you have a 401(k) (an employer-sponsored retirement plan), read on to learn how it can help you get into the home of your dreams.
First, remember the purpose of that 401(k)
It’s called a “qualified retirement plan” for a reason – it is a cushion to use when you leave the work world and settle into retirement.
It needs to be a rather large cushion too, we might add. “On average, Americans believe they need $1.7 million to retire, …” according to Jessica Dickler, citing a recent survey from Charles Schwab at cnbc.com.
A more accurate way to determine how much income you’ll need each month is by dividing your estimated annual expenses by 4%, according to Jean Folger at Investopedia.com.
“So, for example,” she explains, “if you estimate you’ll need $50,000 a year to live comfortably, you’ll need $1.25 million ($50,000 ÷ 0.04) going into retirement.”
There’s a lot to consider when you’re thinking about raiding those funds to pay for a down payment and closing costs for a home. And, although we’ve researched the issue, we aren’t finance professionals, and we urge you to consult with one before making a decision.
Should I withdraw the money or borrow it from my 401(k)?
Keep in mind that “Every employer’s plan has different rules for 401(k) withdrawals and loans, …” warns the experts at fidelity.com. “… so, find out what your plan allows,” they conclude.
Many plans offer the owner the choice of withdrawing the funds from the 401(k) or borrowing them. Both methods of getting your hands on the money have advantages and disadvantages.
“When done for the right reasons, taking a short-term 401(k) loan and paying it back on schedule isn’t necessarily a bad idea,” according to Troy Segal at Investopedia.com.
In essence, you’ll be borrowing the down payment for the home from yourself, and you’ll need to repay that loan, with interest, within 10 years.
Withdrawing the money from your retirement plan brings with it some distinct disadvantages. “Taking money out of a 401(k) plan before age 59 1/2 often results in taxes and penalties,” cautions Rachel Hartman at usnews.com.
This will happen if you’re younger than age 59. You will pay taxes and a 10% penalty upfront.
One advantage of requesting a withdrawal, however, is that there is no requirement to pay back withdrawals, according to the pros at fidelity.com.
Borrowing the money from your 401(k)to help you buy a home allows you to skip paying the taxes and penalty, but you will have to pay interest on what you borrow.
“Depending on what your employer’s plan allows, you could take out as much as 50% of your savings, up to a maximum of $50,000, within a 12-month period (fidelity).
Before you make a decision on either of these 401(k) options, consult with your financial advisor. Most professional advisors “… recommend borrowers tap their 401(k) funds only as a last resort,” claims Gina Freeman at themortgagereports.com.