Using the funds in your 401k to purchase your first home can help you to overcome one of the biggest hurdles of home ownership. It's not without risk, though. That money was meant for your retirement and when you withdraw it early, you lose out on any interest that it could have earned. It may be your only option, but it's smart to consider all of your possibilities before making the decision.
You are allowed to withdraw money from your 401k due to a financial hardship, which can include money for a down payment on your first home. If you are under 59 1/2, though, you are limited to withdrawing only the money that you have contributed; not earnings. Those who are of retirement age can withdraw the entire amount for a home purchase.
Penalties and Taxes
If you are under 59 1/2, you will have to pay a 10 percent early-withdrawal penalty fee for taking out the money. Additionally, everyone who withdraws has to pay tax on the money. When figuring taxes, add the money you withdrew from the 401k to your income. You'll pay taxes at a rate based on your income.
To avoid paying penalties and taxes while still using the money in the 401k for a home purchase, you can take out a 401k loan. In this case, you'll have to pay the principal amount plus interest back to your 401k account within a specified time frame. The limits on taking a loan from your 401k at the time of publication are either 50 percent of the value or $50,000, whichever is less. If you leave your job, though, the money becomes due immediately.
If you have an IRA, you are allowed to withdraw up to $10,000 penalty-free for the purchase of a new home. Though you may still have to pay taxes on the amount, it may be a more attractive option than paying the penalty for your 401k early withdrawal. Other alternatives include a second mortgage or getting a Federal Housing Administration low-down-payment loan, which requires you to pay mortgage interest, but will allow you to keep your retirement nest egg.
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