woman pulls money from a jar labeled retirement; other jars with money are labeled house and college

4 reasons to think twice before using retirement assets to pay for your down payment on a home

By Justin Pogodzinski, CFP®

February 2023

Purchasing a home is one of the biggest financial decisions an individual will make in their life. If you’ve determined owning a home is right for you, the next steps are figuring out how much you can afford and how you’re going to make the down payment.  

If you currently don’t have the funds needed in your bank account to make the down payment, a common thought is to consider your retirement accounts. However, here are 4 reasons why you should think twice before tapping into your retirement accounts to come up with your down payment:

1. You may face early withdrawal penalties, depending on your circumstances

Many individuals have 401(k) plans and IRAs from an employer. While these accounts have similarities, there also can be major differences between them that can negatively impact you if you decide to use them for a down payment.

IRA accounts allow a first-time homebuyer to withdraw $10,000, penalty-free.

401(k) plans are a little more complicated: 

  • If the 401(k) account is from a prior employer, not your current employer, you’ll face taxes and penalties if you make an early withdrawal (prior to age 59.5) from that account 
  • If the 401(k) account is associated with your current employer, you may be allowed to take out a portion of your account balance. However, the company you work for must actually allow for these provisions (not all do). Even if you can take out a loan from your account balance, you’ll be required to pay a portion of the loan back each pay period, and if you can’t pay it back, you’ll be hit with taxes and penalties 

A new retirement bill just passed in December 2022 called SECURE Act 2.0, which added additional rules (and complexity) for being able to withdraw from retirement accounts.  A knowledgeable financial advisor or tax professional can give you advice so you’re not surprised with unexpected taxes and penalties. 

2. You may develop a habit that will reduce your long-term wealth

Once you start withdrawing from your retirement accounts for expenses prior to age 59.5, it can become easier to justify doing it again every time an expense comes up. This can substantially reduce the amount of your assets when you are in your 60s and 70s and no longer working.  

3. You are “breaking the first rule” of compound interest

A famous investor, Charlie Munger, declared, “The first rule of compounding: Never interrupt it unnecessarily.” One of the reasons you’re encouraged to start saving and investing as young as possible is because several decades of uninterrupted compounding can cause your retirement accounts to significantly increase even if you are no longer contributing to them. Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” 

To illustrate the power of compounding, a 2021 report by Vanguard showed the average 401(k) balance for individuals between ages 45 and 54 was $161,079. If a 45-year-old averaged an annualized return of 7% over the next decade, when they are 55 years old, their 401(k) balance would have nearly doubled to $316,866 even if no contributions were made to the account! If the same 7% return continued until age 65 without any contributions or distributions, the balance would have nearly doubled again to $623,324!  

While compound interest can take a long time to make a meaningful difference in an individual’s life, if retirement funds are consistently withdrawn while working, then it will be harder for retirement balances to grow.  

4. The down payment may not be the only expense coming up

As a first-time homebuyer, you may think the only costs to buying a home are your down payment, closing fees and your monthly mortgage payment. However, unexpected expenses can quickly pop up after you close on the house. Examples include renovating the house, purchasing new furniture and appliances, or an unanticipated repair. The result could be you ending up having to withdraw much more from your retirement accounts than you were originally anticipating to be able to cover these expenses.

While it may be tempting to use your retirement funds toward the down payment on a house, you should carefully consider all the ramifications of deciding to do so. There are many mortgage options that could help you make a lower down payment rather than deplete the funds you have set aside for retirement. A financial advisor or tax professional can help you understand how different options will impact your financial health now and far into the future. 

The opinions and insights expressed in this blog are solely those of its author, Justin Pogodzinski, and do not necessarily represent the views of either Mortgage Guaranty Insurance Corporation or any of its parent, affiliates, or subsidiaries (collectively, “MGIC”). Neither MGIC nor any of its officers, directors, employees or agents makes any representations or warranties of any kind regarding the soundness, reliability, accuracy or completeness of any opinion, insight, recommendation, data, or other information contained in this blog, or its suitability for any intended purpose. Baird compliance VK2023-0207 

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Justin Pogodzinski joined Baird in 2014 and is now a financial advisor and a CERTIFIED FINANCIAL PLANNER™ professional with The Nowack Group. Using their combined experience and expertise, he and his business partner, Mike Nowack, specialize in managing wealth for multi-generational families, business owners and remote technology professionals. Justin grew up in New Berlin, Wisconsin, and graduated from Carroll University with a major in finance and a minor in accounting. He now lives in West Bend, where he is active on the board of COLUMNS and in Kiwanis and coaches Special Olympics basketball. In his free time, he enjoys sports, reading and writing.
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