Some young retirement savers are considering raiding their 401(k) accounts to buy a home, a move that experts caution could be detrimental to their long-term financial health. According to the Real Financial Progress Index by BMO Financial Group, nearly one-third (30%) of aspiring homeowners plan to withdraw funds from their 401(k) plans to fund a purchase. This survey, which polled 2,505 U.S. adults this spring, reveals that Millennials and Generation Z are more likely than older generations to consider this option, with 31% and 34% respectively, compared to only 25% of Generation X homebuyers and 16% of baby boomers.

The Risks of Withdrawing from Your 401(k)

“You really, really, really, really shouldn’t be taking out your retirement for a house,” advises Stacy Francis, a certified financial planner and president and CEO of Francis Financial in New York City. Withdrawing from retirement accounts can trigger taxes and a 10% penalty unless specific exceptions apply. For both individual retirement accounts (IRAs) and 401(k)s, qualifying first-time homebuyers may withdraw up to $10,000 penalty-free. Roth IRA owners can withdraw their post-tax contributions at any time without penalty. Despite these provisions, Francis emphasizes, “it’s much better to have those dollars working for you.”

Financial Consequences of Early Withdrawals

Data indicates an increase in savers tapping into their retirement savings, suggesting financial distress among households. In 2023, 3.6% of savers took out hardship withdrawals, up from 2.8% in 2022, according to Vanguard’s How America Saves 2024 preview. Early withdrawals can have significant financial consequences, as explained by Tom Parrish, head of lending at BMO. Not only do they reduce the funds set aside for retirement, but they also often incur penalty fees and taxes.

Clifford Cornell, a certified financial planner and an associate financial advisor at Bone Fide Wealth in New York, highlights the long-term impact: A 30-year-old worker who left $10,000 in their 401(k) instead of withdrawing it could end up with nearly $77,000 more for retirement at age 65, assuming an average annual return of 6%.

Considering a 401(k) Loan

While experts generally advise against taking out loans against your 401(k), it can be a more viable option for meeting down payment or closing costs for a home. Federal law permits workers to borrow up to 50% of their 401(k) account balance or $50,000, whichever is less, without penalty, provided the loan is repaid within five years. “The key thing is to ensure that you pay that back over that period of time,” Parrish said.

However, there are risks associated with 401(k) loans. If you leave your job, whether voluntarily or involuntarily, most employers require the outstanding balance to be repaid quickly. Additionally, overstretching your home budget can lead to significant financial strain. Purchasing a home involves long-term commitments, including ongoing payments for the mortgage, real estate taxes, and maintenance costs.

Weighing the Costs and Benefits

“It’s going to be a very expensive thing for you to do,” Francis notes. She warns that any financial misstep could result in an inability to repay both the 401(k) loan and the mortgage, potentially leading to a deep financial hole.

Experts advise that tapping into retirement savings should be a last resort. Instead, potential homeowners should explore other avenues such as saving more aggressively, reducing current expenses, or exploring first-time homebuyer programs that may offer financial assistance.

The Bottom Line

Ultimately, the decision to withdraw from a 401(k) or take out a loan against it should be made with careful consideration of the long-term financial implications. Consulting with a financial advisor can help in understanding the potential risks and benefits, ensuring that the decision aligns with overall financial goals and retirement planning.

By understanding the complexities and potential pitfalls, young savers can make informed decisions that support both their homeownership dreams and their future financial security.