Can I Use My 401(k) to Buy a House?

It’s become increasingly difficult to buy a home in recent years. Home prices have increased more than 38% from 2020 to 2022, and 20% over the past year.[1]

As the average home price rises, so too does the amount buyers must save for their down payments. If you’re having a difficult time coming up with the money to buy a home, you might be wondering what your options are. For example, if you have money sitting in a 401(k) plan, can you use it to buy a house? We’ll explore that question and more in this article.

A 401(k) plan is an employer-sponsored retirement plan that allows workers to prepare for retirement in a tax-advantaged way. These plans are offered by for-profit corporations. When they enroll in the plan, workers can defer a percentage of their income into the plan.

401(k) contributions can be classified as either traditional or Roth. A traditional contribution is a pre-tax contribution, meaning it comes out of your paycheck before taxes are applied. The money grows tax-deferred in your account, and you’ll pay income taxes on your distributions during retirement. In the case of a Roth 401(k), your contributions are made after-tax. They grow tax-free in the account and you can take tax-free distributions during retirement.[2]

As of 2022, workers can contribute up to $20,500 per year to their 401(k) account, with an additional catch-up contribution of $6,500 per year allowed for workers 50 and older.[3]

Because the money in your 401(k) plan is tax-advantaged and intended for retirement, the Internal Revenue Service imposes certain limits on when you can withdraw it. Generally speaking, you can only take distributions from the plan once you reach age 59½. Any distributions before then could be subject to an additional 10% early withdrawal penalty in addition to any income taxes you owe.[4]

As we mentioned, the IRS discourages withdrawals from a 401(k) plan before you reach 59½. That said, there are some situations where you can take early distributions without a penalty. Exceptions include if you become disabled, have large medical expenses, left your job after age 55 and more.

There are also two specific exceptions that allow you to withdraw money from your 401(k) to purchase a home. One of those exceptions is for a temporary withdrawal, while the other is permanent. However, there are specific requirements you’ll have to meet to withdraw from your 401(k) to buy a home without being stuck with any penalties.[4]

The first way you can use money from your 401(k) to buy a home is through a hardship withdrawal. The IRS allows these withdrawals in cases of an immediate and heavy financial need.

Among the list of purposes for which a hardship distribution can be used is for costs related to the purchase of a primary residence, excluding mortgage payments. However, for the withdrawal to meet the requirements for a hardship distribution, not only must there be an immediate and heavy need, but the distribution must be necessary to satisfy that need.[4]

In other words, if you have enough money in your savings account to pay for your home purchase, you can’t use the money in your 401(k) instead.

Tip

Technically you can make a 401(k) withdrawal to buy a home even if you don’t meet the requirements for a hardship withdrawal. However, that distribution will be subject to the 10% early withdrawal penalty.

Another situation where the money in your 401(k) can be used to buy a home is by taking a loan from your account. Unlike a hardship distribution, a 401(k) loan isn’t a permanent withdrawal. Instead, you’re temporarily taking money from the plan with the intention of paying it off later.

Not every 401(k) plan participant can take a loan from their account. For you to be eligible, your employer must allow 401(k) loans. Additionally, you can only borrow up to 50% of the vested balance or $50,000, whichever is lower.

Once you take a loan from your 401(k), you’ll have to pay it back within five years using substantially level payments. And if you leave your job before the loan is repaid, you may have to either repay the full balance at once or consider it as a taxable distribution, for which you could be on the hook for a 10% penalty.[4]

If you’re considering a 401(k) withdrawal to buy a home, there are a few pros and cons you should be aware of.

Pros

• You can access the funds you need to buy a home without having to wait to save up enough money.

• If you qualify for a hardship distribution, you won’t be subject to a 10% early withdrawal penalty.

Cons

• If you make a withdrawal that doesn’t qualify as a hardship distribution, you’ll be subject to a 10% early withdrawal penalty.

• Regardless of whether you qualify for a hardship distribution, you will be subject to income taxes if you withdraw money from a pre-tax account.

• Money you withdraw from your 401(k) to buy a home is no longer growing in your account to help provide an income during retirement.

There are also some pros and cons of 401(k) loans, though they’re a bit different from those of a 401(k) withdrawal.

Pros

• Because the distribution is temporary, you won’t be subject to income taxes or penalties on the amount you withdraw.

• Unlike a traditional bank loan, you won’t have to meet any credit or debt-to-income ratio (DTI) requirements.

• The interest rate at which you’ll be able to borrow money is lower than the interest rate on most loans.

Cons

• Not all employers allow 401(k) loans.

• You can only borrow up to 50% of your balance or $50,000, whichever is lower.

• Your money won’t grow while it’s not in the account.

• You’ll have to repay the full loan amount if you leave your job, which could lead to staying at a job you’re unhappy with.

There are some advantages to using your 401(k) to buy a home, and it’s easy to see why so many people find this option appealing. That being said, financial experts generally recommend not using your 401(k) balance for this purpose.

“There are serious drawbacks to using your retirement plan savings to buy a home,” says Gigi Verrey, the vice president of wealth services at GCG Financial. “Not only must you pay taxes and a 10% penalty above the $10,000 if you are a first-time homebuyer, but you are also stealing from your potential retirement income. Let’s face it, it is hard enough to save money for retirement with all the 'needs and wants' that compete for our hard-earned dollars and so it is very important to stay disciplined.”

If you follow expert advice and decide not to use your 401(k) balance to buy a home, you still have options available to you. The simplest way to save for any financial goal is to break it down into smaller steps.

“For example, using some simple math, if they need $30,000 in 5 years for a down payment, I have them set up a systematic payment of $500 per month from their paycheck (if available from the employer) or set up a monthly transfer for the same amount from their checking account into the savings account,” Verrey says. “Slow and steady wins the race!”

The type of account you should save in depends on when you plan to buy a home. The most obvious tool available is a savings account. And this is probably the right choice if you plan to use the funds to buy a home within the next few years.

“When helping clients plan for large, future purchases, I suggest they open an interest-bearing account and save monthly into the account,” Verrey says.

If your time horizon—meaning the number of years before you’ll need the money—is longer than a few years, then an investment account might be a better option. An investment account will allow your money to provide a higher return. And because of the longer time horizon, you can afford to take the added risk of investing the money instead of just saving it.

How much can you take out of your 401(k) for a house?

If you’re taking a distribution, there’s not necessarily a limit on how much you can withdraw. However, for a hardship withdrawal, you can only withdraw enough to meet the immediate financial need. In the case of a 401(k) loan, you can withdraw up to $50,000 or 50% of your account balance, whichever is lower.

What reasons can you withdraw from a 401(k) without penalty?

There are many situations where you can withdraw from a 401(k) without penalty, including:

• You reach age 59½

• You become disabled

• You take a hardship distribution

• The beneficiary is made to a beneficiary after your death

• You’re taking a series of substantially equal periodic payments

• You separate from service at or after age 55

• You have a qualified domestic relations order (QDRO) that requires you to make a payment to an alternate payee

• You have medical expenses

• You’re taking a loan you plan to repay

How do I avoid taxes on a 401(k) withdrawal?

Even early 401(k) withdrawals that aren’t subject to the 10% penalty will still be subject to taxation. Generally speaking, the only way you won’t have to pay taxes on funds you withdraw is if you take a loan instead of a distribution. While a Roth IRA allows you to withdraw your contributions without paying taxes on them, a Roth 401(k) early withdrawal is prorated between contributions and earnings, meaning at least some of the distribution will be taxable.[5]