Find out whether it's a good idea to use money in a 401(k) retirement plan to buy a home.
A. A retirement plan—such as a 401(k) or 403(b)—may (but isn’t required to) allow participants to take early distributions.
The IRS allows hardship distributions from retirement plans for certain expenses, including:
- medical expenses
- the purchase of a principal residence
- education expenses
- payment to prevent home foreclosure
- funeral expenses
- repairs to a principal residence
If your retirement plan allows a hardship distribution to buy a main home, it’s important to understand that there are serious consequences for taking a withdrawal.
The first is that distributions are included in your income, which means you’ll have to pay ordinary income tax on the amount you withdraw. Plus, if you’re younger than age 59½, you generally must pay an additional 10% early withdrawal penalty. That’s a big tax hit that I don’t recommend taking.
Another major consequence of taking a hardship distribution is that you’re typically prohibited from making new contributions for at least 6 months after receiving the withdrawal.
Plus, unlike retirement plan loans, hardship distributions are not repaid to your account. They permanently reduce your account balance and leave you with much less money for retirement.
If your retirement plan allows for loans, that’s a better option than taking an early withdrawal. Borrowing from your 401(k) isn’t ideal, but you must repay it to the account with interest over several years.
Read or listen to Should You Take a 401(k) Loan for more information.
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