With the high housing prices in recent years, more and more Americans start to look into their 401k retirement accounts to help with down payment when purchasing a home. Although IRS allows penalty-free 401k withdrawals for first-time home buyers, cashed-out 401k funds can no longer benefit from future tax-deferred growth. There are pros and cons to using 401k for real estate investment. Investors should think through both sides carefully.
The benefits of cashing out 401k for real estate
The most obvious benefit is that 401k funds can be used as down payment and closing costs to buy real estate. For first-time home buyers, up to $10,000 can be withdrawn from IRA accounts penalty-free. For 401k plans, the rules are more complicated but people still have the freedom to utilize their savings. Another benefit is the mortgage interest payments are tax deductible, while penalties on early 401k withdrawals may be avoided.
The risks of cashing out 401k before retirement
The biggest risk is missing out on future tax-deferred growth. Early withdrawals from 401k or IRA accounts trigger income taxes and 10% penalty in most cases. The account holders lose the power of compounding interest over decades. Home buyers may end up with less savings when they eventually retire. Real estate values can go up and down so it’s not guaranteed better return than keeping money in the 401k plan.
Cashing out 401k for real estate down payment has its pros and cons. Investors should think through the trade-offs and make an informed decision based on their personal situations.