How to Use Retirement Funds to Buy a Home

How to tap your retirement for a down payment—and if it’s a good idea.

Laura Adams, MBA
5-minute read
Episode #301

If you want to buy a home, but don’t have enough saved for a down payment, you might wonder if it’s possible to tap your retirement fund for this special occasion.

There are certain situations where using a retirement account to buy a home is allowed. We’ll cover the rules—and whether using retirement savings for a down payment is a good idea.

Buy Now

As an Amazon Associate and a Bookshop.org Affiliate, QDT earns from qualifying purchases.

Click here to subscribe to the weekly Money Girl audio podcast—it’s free!

Tapping a 401(k) to Buy a Home

Retirement plans that you can only get through an employer, such as a 401(k) or 403(b), are the most popular types of retirement accounts. If you have one, there are 2 ways to tap it: taking a loan or making a withdrawal.

Taking a loan from a workplace retirement account is always the best option because you’re obligated to repay yourself with interest over a set period of time. When you take a withdrawal, on the other hand, you’re actually not allowed to repay it except by bumping up the amount you contribute from each paycheck.   

Related Content: 10 Things You Should Know About 401(k) Plans

Taking a Loan from a 401(k)

But not all workplace retirement accounts are set up to allow loans. If they are allowed, there’s a limit to the amount you can get: You can only borrow half of your vested balance, up to $50,000.

Vested funds are those that you own, and you’re always 100% vested in the contributions you make. However, in some cases money from your employer—such as matching or profit-sharing funds—may be tied to a vesting schedule that gives you ownership over time.

Retirement account loans come with a set interest rate and term spelled out in the plan document. The repayment period is typically 5 years, but may be longer for a home purchase. If you repay a loan on time you don’t have to pay income tax or a penalty on the borrowed funds.

However, one of the biggest problems with taking a loan from your 401(k) or 403(b) is that if you don’t repay it on time, the outstanding balance is generally considered an early withdrawal, subject to income tax plus an additional 10% penalty, if you’re younger than age 59½.

If you leave your job or get fired, you’ll probably have to come up with the entire outstanding loan amount within a short period of time, such as 60 days. So be sure to read your retirement plan document or ask your benefits administrator for all the details on taking a loan before signing up.

Related Content: Should You Take a 401(k) Loan?

Taking a Withdrawal from a 401(k)

If your 401(k) or 403(b) doesn’t allow loans, or you need more than the allowable loan amount, you may be eligible to take a “hardship” withdrawal, if permitted by your plan. Certain qualifying events, such as buying, repairing, or preventing foreclosure on a primary home, fall under the hardship category.

But the bad news is that a hardship withdrawal always comes with income taxes and a 10% early withdrawal penalty (if you’re younger than age 59½). Plus, you’re typically restricted from making contributions to your retirement account for 6 months.

Therefore, my recommendation is to never take a hardship withdrawal from a workplace plan. You’ll pay hefty taxes, miss out on contributions and potential employer matching funds, and be left with a depleted retirement account.

Taking a Withdrawal from a Traditional IRA

Another type of retirement account that’s available to just about everyone is the Individual Retirement Arrangement or IRA. You contribute to a traditional IRA on a pre-tax basis and to a Roth IRA on a post-tax basis. With either type of IRA, loans are not permitted, but you can take a withdrawal in certain cases.

For a traditional IRA you’re allowed to withdraw up to $10,000 for a down payment only if you’re a first-time homebuyer. You must pay taxes on the withdrawal—but even if you’re younger than 59½ you won’t get hit with the 10% early withdrawal penalty.

Related Content: How to Raid Your IRA and 401(k) Retirement Accounts

Taking a Withdrawal from a Roth IRA

The rules for taking a withdrawal from a Roth IRA to buy a home are much more favorable than for a traditional IRA.

Since you make contributions to a Roth on an after-tax basis, you can withdraw them for any reason without owing taxes or a penalty, no matter your age. However, if you tap the growth or earnings on your original contributions, taxes and an early withdrawal penalty will apply.

So, if you need to tap a retirement account to buy a home, taking a modest withdrawal from your Roth IRA is the best possible option. However, Roth IRAs are capped so those with higher incomes can’t make contributions.

Related Content: Your Guide to the Roth IRA, Part 1

Owning a home of your own can be a very smart investment, especially with today’s low market prices and interest rates. Just make sure you tap any type of retirement fund with caution because depleting it means you’re giving up the opportunity to build wealth. It’s a good idea to consult with a financial adviser so you carefully weigh the pros and cons of such an important decision.

While taking a loan or withdrawal from a retirement account may make sense for some home buyers, the best scenario is to have plenty of savings so you don’t need to touch your retirement nest egg in the first place.

More Articles and Resources You Might Like:

How to Buy a Home in 10 Steps

What Are the Roth IRA Income Limits?

How to Save Money to Buy a Home, Part 1

The Credit Score Survival Kit – download this free video tutorial

Money Girl’s Smart Moves to Grow Rich – get the paperback or ebook today!

Get More Money Girl!

There’s a huge archive of past articles and podcasts if you type in what you want to learn about in the search bar at the top of the page. Here are all the many places you can connect with me, learn more about personal finance, and ask your money question:

Click here to sign up for the free Money Girl Newsletter!

Download FREE chapters of Money Girl’s Smart Moves to Grow Rich

To learn about how to get out of debt, save money, and build wealth, get a copy of my book Money Girl’s Smart Moves to Grow Rich. It tells you what you need to know about money without bogging you down with what you don’t. It’s available at your favorite book store in print or as an e-book for your Kindle, Nook, iPad, PC, Mac, or smart phone. You can even download 2 free book chapters at SmartMovesToGrowRich.com!

House in a Nest photo from Shutterstock

About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.