What’s All the Fuss About Home Buyers Tapping Their Retirement Accounts?

“I’m not a huge fan. Other people like it,” Trump told reporters. The topic? Home buyers raiding their 401(k) savings to come up with down payments.

The remark created a stir. A Trump adviser had just appeared on the Fox Business channel, saying that a new federal plan would give people better access to their retirement savings for precisely this purpose.

More than half of all U.S. workers have these retirement accounts. Why wouldn’t they appreciate the option of tapping into retirement funds in order to acquire a deed, if necessary? Let’s consider some economic realities here.

Hopeful Buyers Are Struggling to Get Mortgages They Need Today

A typical U.S. house now costs $400K-plus. What does that mean for actual home seekers?

It means a lot of them simply can’t break into the market. Now, or maybe ever. First-time buyers have shrunk as a portion of the market. They now make up only about a fifth of all home sales, says the National Association of REALTORS® (NAR).

No wonder the typical first-time home buyer keeps getting older. NAR reports that the average first-timer is now 40 years old. This is astounding. In 2020, the average first-timer was 33.

So many aspiring deed holders are sidelined. It seems out of touch to tell younger people that using retirement money for a home purchase would raise questions about their priorities. Yet that’s just what one CNBC Financial Advisor Council member has publicly said.

Yes, Using 401(k) Funds to Buy a House Is Still Controversial

The Trump view is that the 401(k)s are doing well, so it’s best not to meddle with them. Many financial advisers say the same thing.  

And yet, for someone who wants to acquire a deed, that could be exactly the reason to tap into those funds. Their account could contain enough to create a down payment.

• Potential deed holders aged 35 to 44 typically have around $40K (median—meaning half are higher, half are lower) stashed away in their 401(k). And this age group’s average account is worth just over $103K. That translates nicely to a down payment.

• Vanguard says the average retirement account holder under 35 has close to $43K. That’s enough for 10% down on the typical U.S. home. Quite a bit more if the home is a modest, starter-type property.

Digging into a retirement account might allow a buyer to put down at least 20%, and avoid the significant costs associated with private mortgage insurance.

In short: Retirement savings can open a path to a deed. And for the younger generations, much could happen between now and retirement. That distant future is uncertain. The need for a home is immediate.

So, What’s the Downside to Spending Down a 401(k) to Obtain a Deed?

When you withdraw from your retirement account, it shrinks, obviously. Plus, there goes the gain you’d have earned on that money through growth, and interest that compounds over time. And to state more of the obvious, you’d be setting your retirement goal back.

Then again, if the stock market is expected to stay on the up and up, as Trump seems to think, then wouldn’t a raided retirement account be expected to make a rebound? Why should the younger generations deny themselves deeds, while continuing to contribute to the stock market?

It’s a fair question.

Check the Account: Some 401(k) Plans Allow Hardship Withdrawals

The vast majority of 401(k) accounts can be tapped for “hardship” reasons. This is one way for younger people to draw from their savings to get access to a mortgage and a deed. Withdrawals will be taxed, as they are at any time the account holder takes them out. Expect to owe the 10% early withdrawal penalty if you’re under 59½ years old.

Hardship withdrawals aren’t so appealing after all, unless the working person is really in a bind.

Vanguard told CNBC that some 35% of hardship withdrawals are tapped by savers needing to stop evictions or foreclosures. Those are the chief reasons people get into hardship withdrawals. But another 16% of those customers pulled the money out to buy or fix up homes. In other words, taking a hardship withdrawal is a thing some home buyers do. But it has its drawbacks.

Isn’t There a Special Provision for First-Time Buyers?

Yes.

Under the law as it stands, first-time homebuyers can pull $10K from retirement accounts to fund down payments, without getting hit by the standard 10% penalty on account distributions taken before age 59½. Great!

But there’s a drawback here too.

Although there’s no actual penalty for taking them out, these funds were part of your employment income. They went into your retirement account on a tax deferred basis. That is, you were going to have to pay taxes on them when using them for support in retirement.

That money now becomes income—to be added to all the regular income you’re going to be taxed on for the year. 

Instead of Taking Money Out of It, Can’t You Just Borrow Against the Account?

Four out of five accounts let the holder borrow against them to purchase a house. If yours does, then to avoid depleting your retirement funds, and also to avoid the early withdrawal penalty, you can borrow against the account instead. And you don’t have to pay taxes on the loan, given that it’s not a final draw from your account. But the process and terms may be dealbreakers:

• Of course, the funds must be paid back in. You’re going to repay yourself—with interest.

• You must accept payroll deductions to repay the loan.

• You have to repay the loan within the span of time your employer has set (commonly five years).

• You’ll have to stay with the same company. Leave, and the loan is due in full. With a penalty. And if you’re unable to pay it off, it’ll be as though you took a distribution (subject to tax)!

Interested readers should ask their employers how much they can borrow and the details of the process.

Important note: We do not dispense financial advice. For that, you need to hire a financial expert who looks specifically at your situation. Reputable mortgage brokers are also very helpful in guiding their clients through the financial maze that makes up a journey to a mortgage approval.