Why Using Your 401(k) to Buy a Home Can Backfire
As part of a campaign to tackle housing affordability, the Trump administration has scrapped the idea of allowing workers to use their retirement accounts to pay for a home.
In an interview with Fox Business, National Economic Council director Kevin Hassett said, “We’re going to allow people to take money out of their 401(k)s and use it to pay.”
There are many unanswered questions about how the plan will work, such as what types of accounts other than 401(k)s may qualify and how much money a person can withdraw. The Plan Sponsor Council of America, a trade group for the retirement plan industry, notes that turning this into policy “may require new legislation.”
Homebuyers already have some options for using retirement savings to pay for a home. Under existing rules, retirement savers are allowed to take up to $10,000 from an individual retirement account, or IRA, to buy a first home without incurring the 10% early withdrawal penalty that is usually triggered if you withdraw before age 59 1/2.
This rule only applies to IRAs, not employer-sponsored accounts, but employees with 401(k)s also have another option: They can borrow from them, up to the lesser of 50% of the balance provided or $50,000.
From a policy perspective, the idea of adding more flexibility to retirement accounts may sound appealing, said Anqi Chen, director of household savings and finance at the Center for Retirement Research at Boston College.
“The biggest thing I think is that making 401(k) savings easier for other purposes might encourage higher contributions or more participation,” he said.
Americans aren’t saving enough for retirement as it is, and many aren’t even saving enough to qualify for an employer matching contribution – basically leaving “free money” on the table. Chen says that workers may be more willing to contribute to a retirement account if they have confidence that they can use those funds when needed.
There are many unintended consequences
The problem is that tapping those funds disrupts the process that makes long-term investing a reliable way to build a nest egg.
“You lose the power of compounding,” says Scott Cole, founder and president of Cole Financial Planning and Wealth Management. “What you can’t change in the market is time. The longer you can consolidate, the more power you have.”
While both stocks and real estate generally appreciate over time, there are significant differences between the two asset classes, Chen said. Money invested in something like a target date fund within a 401(k) “grows in a more stable, more transparent way, whereas in real estate, it varies more geographically,” Chen said.
Securities are extremely liquid; in other words, they are easy to sell and turn into cash. While home ownership is certainly a tool that people use to build wealth, home equity is not liquid, Cole notes. “You need money to use when you retire,” he says. “And when it comes time to retire, you can’t use that equity unless you sell the house.”
President Trump himself appeared to acknowledge that creating a new way to affect 401(k) assets could disrupt people’s retirement goals in remarks he made Thursday. “I like to keep their 401(k)s,” he said, because “401(k)s do very well.”
This idea may lead to other unintended consequences, too. Suddenly having access to another pool of money can skew a prospective homebuyer’s budget, adds Cole.
“You’re probably being pushed to buy more house than you need,” which can lead to higher mortgage payments and higher maintenance and property tax bills.
“There is a problem, when you give people more options, they always know how to make the best decisions,” said Rich Arzaga, principal at Real Estate Whisperer Financial Planning and adjunct professor at the University of California, Berkeley Extension.
Based on his experience with real estate investing, Arzaga notes that people’s emotions can have a big impact when it comes to buying a home. “The real concern I have is when people see the American dream in front of them and all it takes is $50,000 or $100,000.. They are confused and upset, [and] when people get emotional about things, they don’t make the best financial decisions.
There’s another serious problem, he adds: Sinking a large portion of your retirement savings into a home creates a greater risk of bankruptcy.
“If you take $100,000 and put it into a house, suddenly you have a very concentrated position. You have a lot of equity in one asset,” Arzaga said. Just as you wouldn’t bet your nest egg on a single company’s performance, you don’t want your future financial security to be determined by changes in the real estate market.
Trading your nest egg for a loan is a risk that could easily set you back, he warns. “If you look at this from a retirement planning perspective, it’s better for most people to leave the money in the 401(k) and let it grow.”
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