Why workers may not want to tap retirement savings to buy a home

Some young retirement savers say they might raid their 401(k) accounts to buy a home. Doing so, however, could be to their detriment, experts warn.

Nearly one-third (30%) of aspiring homeowners say they plan to withdraw funds from their 401(k) plan to fund a purchase, according to the Real Financial Progress Index by BMO Financial Group. BMO polled 2,505 U.S. adults this spring.

Millennials and Generation Z are more likely than older generations to say they will pull out money from their 401(k), BMO found, at 31% and 34%, respectively. To compare, only 25% of Generation X homebuyers and 16% of baby boomers plan to withdraw retirement funds for a home purchase.

“You really, really, really, really shouldn’t be taking out your retirement for a house,” said Stacy Francis, a certified financial planner and president and CEO of Francis Financial in New York City.

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Generally, early withdrawals from retirement accounts can trigger taxes and a 10% penalty, unless the account owner meets a listed exception. For both individual retirement accounts and 401(k)s, qualifying first-time homebuyers may be able to take up to $10,000 penalty-free. With Roth IRAs, owners can withdraw their post-tax contributions at any time without penalty.

Still, “it’s much better to have those dollars working for you,” said Francis, a member of the CNBC Financial Advisor Council.

While a 401(k) loan might be a better option to meet necessary payments for a home purchase, doing so entails its own set of financial risks, experts say.

More savers tapped into their retirement savings last year, which experts say shows that some households were facing financial distress. In 2023, 3.6% of savers took out hardship withdrawals, up from 2.8% in 2022, according to Vanguard’s How America Saves 2024 preview.

But making withdrawals from your 401(k) plan can have “significant financial consequences,” said Tom Parrish, head of lending at BMO. Not only will you be denting your funds set aside for retirement, early withdrawals can also often subject you to associated penalty fees and taxes, he said.

“There’s a reason there’s limitations to these accounts. They’re in your favor,” said Clifford Cornell, a certified financial planner and an associate financial advisor at Bone Fide Wealth in New York.

For example, a 30-year-old worker who left $10,000 in their 401(k) instead of withdrawing it could end up with nearly $77,000 more for retirement at age 65, assuming average annual returns of 6%.

While experts say taking out a loan against your 401(k) is generally a bad idea, it can be a more palatable option for the down payment or part of closing costs of a home, versus a withdrawal.

Federal law allows workers to borrow up to 50% of their 401(k) account balance or $50,000, whichever is less, without penalty as long as the loan is repaid within five years.

“The key thing is to ensure that you pay that back over that period of time,” Parrish said.

However, if you leave your company — whether you’re laid off or find a new job — most employers will require your outstanding balance be repaid more quickly.

Another risk is that you overstretch on your home budget. Purchasing a home entails long-term, real commitments, said Francis. Not only are buyers responsible for down payment, moving and closing costs, they then also have ongoing payments for the mortgage, real estate taxes and maintenance costs to consider.

“It’s going to be a very expensive thing for you to do,” she said. If “any little domino falls the wrong way,” you might not be able to pay neither the 401(k) loan nor the mortgage, putting yourself in a “real deep financial hole,” Francis said.