Buying a Home with Your 401(k)
A common question that we receive from clients is, “can I make use of my 401(k) to buy a new home?”
This is a common question you get from people who have a 401(k) account and are seeking to get a new home. Before we go deep into whether you can use your 401(k) savings to buy a house or not, and how you can do this, we are going to delve a little into what 401(k) is and how it works.
What is 401(k)?
401(k) is a retirement savings plan for an employee, and it is sponsored by the employer. This plan is designed to allow workers to save a portion of their earnings before taxes are deducted. With this plan, the employee pays no tax on the investment until the money is withdrawn from the 401(k).
The plan has grown to become the most popular of all employer-sponsored retirement plans in the United States. While the deduction for the plan is often made before tax, an employee can choose to opt for the option that allows post-tax payment. The plan which allows post-tax payment is called Roth 401(k)s. For 401(k) accounts that allow payment before tax is removed, the deduction is made upon withdrawal of such funds.
“Typically, when allowed, the loan amount is limited to 50% of the 401(k) account balance up to $50,000.”
The annual limit for a 401(k) plan is $18,000, however, employees who are 50 years or older by the end of the year can make catch-up contributions, which can be an additional funding of up to $6,000. For an employer/employee joint contribution, the limit is $54,000 and $59,000 for those who are 50 years and above. However, assets in a 401(k) account cannot be withdrawn unless some conditions are met. These conditions include:
- The first is when the employee retires, dies, becomes disabled or stops working with the employer
- The second is when the employee reaches the age of 59 ½
- Also, the money can be withdrawn if the employee experiences a financial hardship
- The last one is when an employee or employer terminates the plan
Many sponsored 401(k) plans allow for an employee to borrow from the plan. Typically, when allowed, the loan amount is limited to 50% of the 401(k) account balance up to $50,000. The most interesting part of a 401(k) loan is that there is no tax deduction on it. However, the standard duration for repayment is 5 years, if an employee does not pay back within this duration, he or she will have to pay a penalty. Also, if by any chance the employee decides to leave his or her place of employment, then such a person normally has around 6 months for repayment. It is always advisable that it is critically thought out before taking the loan; for someone who is not sure about their commitment to a job. Remember, a 401(k) loan is basically borrowing from yourself, and repaying yourself with interest.
Using a 401(k) to buy a new home
Having understood how a 401(k) works, we can now look at how you can use your 401(k) plan to buy a new home, and what your options are.
If you are trying to use 401(k) to buy a new house, you should know that it is very possible, you should also know that you have two options:
- The first option is to withdraw from your 401(k) and use it to buy the house.
- The second option is to get a 401(k) loan and make a repayment on it.
Both options are good for buying a new home, and you can choose to explore either of the two. However, for you to have a deep understanding of the two, we are going to discuss some of the things should know before opting for one ahead of the other.
If you want to withdraw from your 401(k) to buy a new home, you should know that anyone who is not 59 or older is not eligible to withdraw from a 401(k) without penalty. If you are below that age bracket and you are trying to withdraw from 401(k), you will have to make use of hardship withdrawal, however, you will incur a 10% penalty and 10% income taxation.
“anyone who is not 59 or older is not eligible to withdraw from a 401(k) without penalty”
The second option is to get a loan from the 401(k) account. As we have stated earlier, it is possible that you get up to a 50% loan from your 401(k) account. Getting a loan is often the preferred of the two. When you get a loan, you will not be required to pay the 10% penalty or any tax. The normal duration for refunding of the loan is 5 years. The loan payments will also normally not impact you DTI’s. Financial experts also advise that it is better to go with the option that involves no penalty than to go with one that involves a penalty. The only case when it is not advisable to take a loan is when you know that you will soon move out of the job before completing the refunding plan.
To learn more about using your 401(k) to buy your home, contact a Houz Mortgage Loan Advisor and your 401(k) Administrator.