What do you do when you want to buy a home but lack the money for a down payment? Dipping into your retirement savings by taking a withdrawal from a 401(k) or IRA may seem like an obvious answer, but doing so can come with serious drawbacks. Here, we cover four of the more serious issues associated with withdrawing money from a retirement account to purchase a home.

1. Early penalties

If you take money from a 401(k) or traditional IRA before you hit age 59 1/2, you’re likely to be hit with a 10% penalty. Let’s say you withdraw $50,000. If you’re not 59 1/2 yet, you’ll owe a $5,000 penalty right away.

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There are exceptions to the 10% penalty even if you’re younger than 59 1/2. These include plans that make allowances for certain first-time homebuyers as well as for qualifying hardship withdrawals.

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2. Taxes

Regardless of penalties, if you take money from a pre-tax plan like a traditional IRA or 401(k), you’ll owe taxes at your ordinary tax rate.

3. Opportunity cost

The term “opportunity cost” refers to what you give up by choosing one option over another. In this case, choosing to take money from a retirement account to purchase a home means giving up the opportunity to watch those funds (potentially) grow for retirement.

Say there’s a dip in the market. It’s when the market sags that money in a retirement account is used to scoop up low-cost deals. As the market recovers, those new investments become more valuable, enhancing the value of your overall portfolio. When you withdraw funds, there’s less money available to take advantage of great deals.

4. Reduced security in retirement

Any money withdrawn can leave you with a significant hole in your retirement fund. Let’s say you withdraw $25,000 at age 35. Immediately, you face a loss of $2,500 due to the 10% penalty assessed on the money. You must also pay taxes on the funds that tax year, which puts a dent in the amount of money you have available for a home.

Further, imagine that you plan to retire at your full retirement age (FRA) of 67. If you leave the money in a retirement account with an annual average return of 7%, the $25,000 would grow to roughly $217,882 by the time you retire.

While it’s true that home values have grown dramatically since the beginning of pandemic lockdowns in 2020, that rapid growth has been a historical hiccup. Returns for the stock market have crushed real estate returns historically. We may not be able to predict the future, but tracking across many decades indicates that the market is a better bet than real estate in terms of growth.

Before making a final decision, you may want to consider these options:

• If you’re a first-time home buyer, ask your retirement plan administrator if the plan allows for hardship loans.
• Look into low-down-payment home loans. If you qualify for a federal government mortgage program, such as an FHA or VA loan, you won’t have to come up with as much cash.

Finally, ask your real estate agent to help you investigate state or local government down payment assistance programs. The less money you have to come up with, the more you’ll have in your retirement account to propel it forward.

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