How to Withdraw from Your 401k or IRA for the Down Payment on a House

If you’re a relatively new home buyer, you might be wondering how you can afford a down payment. House prices are on the rise, and you’re only just getting started. Fortunately, you have multiple options. At Cher, we aim to provide you the resources to make house buying easy. With that in mind, here’s our guide to what you can do.

401k Plan

The 401k is a retirement plan offered by companies for their employees where the employee contributes towards their retirement plan and the company matches their contribution. There are two types of 401k plans: The traditional 401k plan and the Roth 401k.

The primary difference between the two is that they are taxed differently. The Roth 401k accounts allow contributions that have already been taxed, enabling contributors to make tax-free withdrawals. Traditional 401k accounts accept their contributions beforehand, so the withdrawals incur taxes.

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Individual Retirement Account (IRA)

An IRA is a retirement investment resource for individuals to set aside and grow their retirement savings. Investments in IRAs can range from mutual funds to bonds and stocks. There are four primary types of IRA accounts: traditional, Roth, Simple and SEP IRAs.

The traditional IRA contributions are tax-deductible, so they will be taxed upon withdrawal. Roth IRAs are not tax-deductible, so they are not subject to any taxation. SEP (simplified employee pension) is an IRA for self-employed individuals. It operates like a traditional IRA so the funds are taxed upon withdrawal. Finally, the savings incentive match plan for employees is called the SIMPLE IRA. Also for self-employed businesses, it also covers small businesses and it works like the traditional IRA.

How to withdraw from 401k plans

There are three main factors that come into play when withdrawing from a 401k account:

  • The terms of the 401k plan
  • Current employment status of the account holder
  • The age of the account holder

Withdrawal from any 401k plan before the age of 59.5 years incurs a penalty. And this isn’t the only challenge one may encounter when withdrawing early from 401k accounts. If the employer doesn’t allow early withdrawals, then the employee has to work with the Human Resources department and their Accounting department to ascertain the type of withdrawal they’re allowed.

Typically, this is information that can be found on the 401k plan the employee agreed to and signed. Early withdrawal from a 401k plan account will result in an early withdrawal penalty of 10%.

The withdrawal can still occur if the employee withdraws through the in-service distribution option. This means the employee cites the difficulty and if it qualifies as a reason for the withdrawal, then penalties may be reduced. The majority of 401k retirement plans available in the U.S. allow in-service withdrawals under certain proven conditions.

The alternative, if one still wants to withdraw from their 401k account, is borrowing against their account balance. They can receive half of their invested balance or a maximum of 50,000 dollars depending on the agreed terms with the employer.

The final option is invoking the hardship withdrawal. For example, if the employee lost a previous house to a natural disaster or it was damaged, that’s a hardship that may justify withdrawing the money to put a down payment on another home.

Use Cher, the accessible home-buying process to make each step easier for you.

How to withdraw from IRA accounts

Unlike 401k plans, one can withdraw from an IRA account early and for any reason. Depending on the IRA agreement signed, there may be penalties and/or taxes owed. However, if no penalties or taxes apply like the case of a Roth IRA account, then the withdrawal is completely free.

The biggest advantage IRA early withdrawal has over 401k plan withdrawals is that one can avoid the early withdrawal penalty altogether if they’re purchasing a first time home. Other penalty-free reasons allowed by IRA include

  • To pay back IRS taxes levied on IRA
  • To pay for an education
  • To take care of medical expenses
  • In case of a permanent disability or death of the account holder

The penalty incurred for early withdrawal of funds is also 10% for an IRA account. Unfortunately, it’s impossible to get an IRA loan because they do not exist.

Which is the better option?

For many, the question of whether they can withdraw their contributions early or not is a huge determining factor in choosing either a 401K plan or an IRA account.

With major similarities like tax advantage growth possibilities and the potential to lessen the income tax burden of account holders, these retirement plans are a great option for future financial stability.

They both also offer a way out for those who want to withdraw their funds earlier, but it’s not without cost. However, it may be a better option to choose the Roth IRA account. This is because withdrawals made before the maturity age of the account (59.5 years) will still not be taxed or penalized on the condition that the amount withdrawn is less than the total contributions in the account.

It is important to remember that employers may be willing to match the contribution made by an employee on their 401k plan. However, that does not apply to employees with IRA plans. Employers don’t make matching contributions to IRA accounts. Over the course of an individual’s time with an employer, this can be a huge loss compared to the additional money gained for free that flows into the 401k.

It’s recommended that you read and understand the fine print for both 401k plans and IRA accounts before choosing one.

There are clear consequences to the distribution plan one chooses, and your choice affects your ability to invest in something as important as a home. Considering the fact that the money being put away in either account is for future financial stability, they should be a go-to option when planning on a future investment. Check out our resources at Cher to find out more about the house-buying process.