(The following is a guest post)
If you’re looking to buy a home, but you’re struggling to find enough money to cover the down payment, you may have considered using your 401k to make up the difference. With a 401k, there are two main options available to you – you could take out a loan on your 401k, or you could request a ‘hardship’ withdrawal. But, are either of these options a good idea?
The law allows you to take out a hardship withdrawal from your 401k to buy or keep your primary home. However, going down this route will have a number of drawbacks.
You will need to prove that you ‘need’ the money, that you are under hardship. While the law allows for this type of early distribution, that does not mean your employer is obliged to offer it to you. Different plans will have different rules, and your employer will have the ultimate say in whether you have access to the withdrawal.
There are also taxes and penalties involved – to stop people just withdrawing money when it suits them, to then be left with no money when they retire. If you are younger than 59½, the money you withdraw from your 401k will be subject to an array of taxes and penalties, including a 10% ‘early withdrawal penalty’.
And of course, there is also the fact that you are depleting your retirement savings. Taking money from your retirement funds now will mean less is available to you when you retire. Bear in mind that after you take out the withdrawal, you will be barred from contributing to your 401k for six months.
Taking out a 401k loan is usually thought of as a better option than a hardship withdrawal. The law states that you are allowed to borrow up to half of your vested balance or $50,000 – whichever is less – without you having to pay taxes or penalties.
When you take out a 401k loan, you are borrowing from the money already paid into your 401k. When you take out the loan, the stocks or bonds held within the 401k are sold to provide you with the funds. You then pay the principal plus interest back into your 401k.
Your employer will set the rate of interest, and you will usually have to repay the loan within five years – although a loan for a house purchase can sometimes be taken out over a longer period, up to 15 years.
Again, it will be up to your employer to set the terms of the loan, and how long the loan will last for. However, the biggest risk with a 401k loan is losing your job. Some employers demand immediate repayment of the loan, and if you are unable to pay, you will be subject to taxes and the 10% early withdrawal penalty.
Nevertheless, some employers allow 60 days for repayment, and some allow ex-employees to continue paying their agreed repayment schedule. Check the terms and conditions of the loan before you sign up, so you know exactly what you’re getting into.
Speak to a Professional
If you are thinking about withdrawing or borrowing from your 401k, click here to speak to a professional today, the best thing to do is speak to a tax expert or financial adviser. They could advise you of a better way to raise funds for the purchase of your house, or they may be able to advise you the best way to get the most out of your 401k, without losing out too much.
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