Why You Should Never Use Your 401(K) for a Home Purchase?

Why You Should Never Use Your 401(K) for a Home Purchase?
  • Opening Intro -

    Everyone hopes to one day own their dream home, but some want it so badly that they are willing to use their 401(k) for a down payment.

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Before you tap into your retirement savings, take a few moments to consider the real impact a 401(k) withdrawal for a home purchase will have on your future.

What is a 401(k)?

First, it’s important to understand exactly what your 401(k) is. Your 401(k) is a company-sponsored savings account with many benefits to encourage employees to save for retirement.

It was originally passed in 1978, where the 401(k) section was added to the Internal Revenue Code. Of the many benefits, the 401(k) is most known for its lack of taxation.

Any income you contribute to your 401(k) and any returns generated from your 401(k) are not taxable. In other words, you can reduce your taxable income.

But how do no taxes on your returns benefit you? The only way to earn passive returns on your 401(k) is to make investments, which include equities, bonds, etc. Usually, these returns are considered capital gains and are taxed, but in the context of a 401(k), you keep 100% of this income.

The last main benefit of a 401(k) is that many employers will offer to match contributions on some level so that your contributions are amplified. Essentially, you are getting free money from your employer.

What’s the catch?

You’re probably thinking that these are simply amazing benefits and you would be right to think so. The government actively makes these benefits great to encourage responsible saving. But they also want to make sure that you keep being responsible.

If you are less than 59 and a half years of age, then the government imposes some heavy penalties on both early withdrawals and 401(k) loans.

With a withdrawal, you will end up paying a 10% penalty and the withdrawn amount will be added to your taxable income.

If you get a 401(k) loan, then you’ll have to repay it with interest and you won’t be allowed to make any additional contributions during the loan term. Both of these options mean you lose out on the potential of a 401(k).

Why shouldn’t you use your 401(k) for a down payment?

But why does this matter to you? Unfortunately, a mortgage down payment is a very large barrier to getting a home and is often the last thing that you need to overcome.

People often get swept up in the idea of owning such a large livable asset that appreciates, but take a moment to consider what’s best. If you end up using your 401(k) to pay for your house, then you will miss out on another large opportunity, the stock market.

As mentioned, with a 401(k), you can invest in whatever you like and any returns are tax-free. That’s why so many people invest as much as they can afford.

It is the best option for your money after paying off debt. The US stock market has been booming and returns have been phenomenal.

Within the past year, the Dow Jones Industrial Average made a staggering 42% return, and the market is expected to continue growing for a bit longer, so it’s worth it to hold off on your home purchase.

How will it impact your savings?

If you take money from your 401(k), your retirement account growth will take an enormous hit. With the market doing so well, buying a house would be giving up an amazing opportunity even though a house will always be available.

Not only that, if you decide later that you do want to invest, most of your money would be locked up in a mortgage and you would be stuck repaying a loan or losing that money in your home for good.

For reference, if you took out just $50,000 for a down payment, you would be $215,000 poorer in 30 years at a return of 5%. If instead you invested your money now and saved up using other money for a home, smart investments could very well make you a millionaire.

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So what’s the plan?

If at all possible, do use other sources of money for your down payment. If you absolutely MUST get a home now, then your 401(k) should be your absolute last resort.

You can check your other savings accounts, first-time home buyer programs, personal loans, or even loans from friends and family. Even if you have an extra source of income, you should be investing it in the market. Returns are at an all-time high, so you should take advantage of this opportunity.

When the time to buy your home does arrive, you should be able to do so without tapping into one of your most valuable assets. For now, build up your savings and keep investing your money.

Image Credit: never use your 401(k) by twenty20.com

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