Drawing funds from a retirement account to make a down payment on a house can help get you in a house quicker. Having more money in retirement, however, is another matter.
Retirees or near-retirees who want to buy a house somewhere else for retirement may have a difficult time coming up with a down payment if they can't sell their existing home for much of a profit.
They may have a large sum of money in a retirement account, and be tempted to use some of it for the down payment, or to borrow from the fund. Pulling from a retirement account can be a good and bad idea. First, the bad:
One of the biggest arguments against it is that the money withdrawn today could have grown to a lot more if left in a retirement account for years.
"The single biggest problem with making a withdrawal from your retirement account to put toward a down payment on a home is that you are sacrificing the long-term compounding ability of that money," says Jonathan Duong, a chartered financial analyst and president of Wealth Engineers in Denver.
"Whereas a typical diversified retirement portfolio might generate average returns of 6 to 7 percent a year, residential real estate generally appreciates at about the rate of inflation," Duong says. "Over the long haul, this can reduce the growth of that money by a factor of two or three times."
Money can be borrowed from a Roth IRA for any purpose, including buying a home, though it's not something that Alan Moore, a certified financial planner and founder of Serenity Financial Consulting in Milwaukee, recommends.
"While the money may be accessible, it doesn't mean you should use it," Moore says. "When you take money out of an IRA, you can't put it back in so you are forever stuck with less money saved for retirement."
For example, assuming someone with 30 years until retirement can earn 8 percent in the market, taking $10,000 from a traditional IRA can cost $2,500 in taxes and mean missing out on more than $90,000 in growth, he says.
Taking money from a traditional IRA or a 401(k) will require paying federal and state income taxes, which could add up to 30 percent, says Stuart Ritter, vice president and senior financial planner at T. Rowe Price.
Taking out $10,000 for a down payment could mean needing closer to $15,000 so the taxes can be paid, Ritter says. The withdrawal could propel you into a higher tax bracket.
Moore says he's "never seen a case where it made sense to spend retirement money on a down payment for a home." However, for people who haven't owned a home for the last two years and are younger than 59-1/2, they can withdraw up to $10,000 from a Traditional or Roth IRA and put it toward a home purchase. It avoids a 10 percent tax penalty, though taxes must still be paid on the withdrawal.
There are different rules for an early withdrawal from a 401(k), which is essentially borrowing from yourself with a loan that must be repaid. The plans typically have a loan provision allowing for up to 50 percent of the vested balance up to $50,000 to be borrowed, says Bradley H. Bofford, managing partner with Financial Principles in Fairfield, N.J.
They won't incur taxes or early withdrawal penalties, and can have loan payments as a direct payroll deduction for one to five years, sometimes up to 10 years, Bofford says. The risk is that if the employee leaves or is terminated, they'll have to repay the loan immediately to avoid having the remaining balance of the loan taxed as ordinary income, and a potential 10 percent penalty for early withdrawals if their younger than 59-1/2, he says.
When it can make sense
Downsizing to an affordable area with a low house payment is a common move among retirees, says Wendy Cutrufelli, a mortgage expert at Bank of the West.
But with little or no income, they'll need to prove the ability to repay by having two to six months of financial reserves after closing on the loan, Cutrufelli, says, because retirement accounts aren't counted as income in home loans. New rules, however, can help retirees qualify for mortgages with their retirement savings.
"To be prudent, don't actually cash it out until they have full loan approval," she recommends.
Finding cheaper housing
Retired lawyer Boyd Lemon, 73, is in the process of using retirement savings to buy a home in Saint Marys, Georgia, mainly because it's an affordable area and his house payment will be lower than his rent. Currently a renter, Lemon expects to save $300 to $350 per month by buying a home for $120,000 with a $25,000 down payment from his retirement funds.
"I can lower my cost of housing by buying a home," he says, including taxes and insurance on the home.
Lemon, author of the book "Retirement: A Memoir and Guide," is using money from what he calls a "rainy day fund for retirement."
"That cash won't adversely affect my standard of living because I didn't set that money aside to spend," he says.
Needing a little extra
While Duong, the financial analyst, doesn't recommend using retirement funds for a down payment, he says he does see the benefit if it can help a home buyer avoid paying private mortgage insurance by having a little more money for a down payment and possibly a lower mortgage interest rate.
"The only pro I could see is if you are right on the border of having a 20 percent down payment and you need a couple thousand extra to get you there," he says, adding that it should be a penalty-free withdrawal.
Using retirement funds to buy that beach house you've always wanted can make sense if you have enough money for retirement expenses. But a better way may be to do what homebuyers often do anyway - save money specifically for buying a home.