Using Home Equity to Fund Your Retirement Account

It can be challenging to save for your older years and salt away enough funds that will hopefully grow over time into a large nest egg you can count on to retire comfortably.

That begs an interesting question: Can and should you tap into your home’s equity to help fund your 401(k), IRA, or other retirement account? The answer will depend on several factors and what your retirement account allows. Read on for more details and tips from financial experts. 

Home equity options

First, it’s important to know the three main ways you can tap into your home’s equity: a home equity loan, home equity line of credit (HELOC), or cash-out mortgage refinance loan.

A home equity loan has a fixed interest rate and a term ranging from five to 30 years. This type of loan provides borrowed funds in a lump sum payment at the time of closing.

As with a HELOC and cash-out refi, you’ll pay closing costs, which may amount to 2% to 5% of the loan amount. Additionally, you’ll likely need to have at least 20% equity in your primary residence to qualify for this type of loan.

A HELOC works like a credit card, offering the flexibility to borrow multiple times up to a predetermined maximum amount. Unlike a lump sum, a HELOC provides access to a revolving line of credit during a specified draw period, often spanning 10 years.

As you repay the borrowed amount, your available credit replenishes, enabling future borrowing as needed, up to your credit limit. Following the draw period, typically lasting 20 years, the repayment phase commences.

HELOCs commonly involve adjustable interest rates, potentially resulting in higher total interest payments compared to a home equity loan.

Or, instead of pursuing a second mortgage through a home equity loan or HELOC, you can replace your existing primary residence mortgage with a potentially larger loan in the form of a cash-out mortgage refinance loan. Here, you get a lump sum paid out at closing.

What’s allowed

Want to pad your retirement account with extra funds gained from a home equity loan, HELOC, or cash-out refi? Not so fast: Some types of accounts don’t allow this.

For example, 401(k) plans are considered workplace retirement plans, which means the money usually needs to come from your paycheck via your employer’s payroll. 401(k) plans are also subject to specific IRS regulations and IRS-established annual contribution limits. Borrowed funds, such as those from a home equity loan, cannot be used to make contributions to a 401(k) plan.

Other types of retirement accounts, including a traditional IRA, Roth IRA, or Simplified Employee Pension (SEP) IRA, may allow you to use funds from home equity, but with caveats. Contributions to traditional IRAs and SEP-IRAs are usually funded with pre-tax dollars.

However, utilizing post-tax funds from a HELOC, home equity loan, or cash-out refinance loan to contribute to an IRA or SEP-IRA essentially involves borrowing money for investment purposes. This scenario may result in complexities related to the tax deductibility of interest and the tax implications of IRA contributions.

There are also annual contribution limits in place for traditional, Roth, and SEP-IRAs. The 2024 contribution limits for traditional and Roth IRAs are $7,000 for those under age 50 and $8,000 for those 50 and older.

For a SEP-IRA, you are allowed to contribute up to 25% of your total compensation or a maximum of $69,000 for the 2024 tax year, whichever amount is less. 

The benefits of using home equity to fund a retirement account

Utilizing your home’s equity to bolster an IRA can offer some advantages. 

“The main benefit of using home equity to fund your retirement is that home equity loan, HELOC, or mortgage interest is tax deductible, potentially lowering the cost of borrowing,” says Liam Hunt, director of GoldIRAGuide.org. “Contributing to retirement accounts can also be tax-advantaged, either through tax-deferred growth or tax-free withdrawals, depending on the account type.”

Another plus? “You can have immediate funds that you can put to use right away for retirement contributions. This may help your retirement savings grow more quickly, but is highly contingent upon your rate of return,” says Jason B. Ball, a Certified Financial Planner.

Per personal finance expert Andrew Lokenauth, good candidates for this strategy include those who are close to retirement with high home values, substantial equity, and limited savings options.

“These individuals may find it beneficial if they stay disciplined on repaying what they owe punctually,” he says. 

Conversely, this approach is less appropriate for those with unstable income or newer mortgages early in their term, adds Ball.

The risks of using home equity to fund a retirement account 

Make no mistake: There are plenty of pitfalls associated with funding retirement accounts using liquidated home equity.

For starters, current interest rates for home equity loans, HELOCs, and cash-out refinance mortgage loans are higher than they were years ago (although rates are beginning to drop lately).

Considering that fixed rates for a cash-out refinance loan or home equity loan are averaging around 7% and 8%, respectively, and that HELOC rates can go even higher than these after the introductory fixed-rate phase ends, it may not make sense to tap home equity to fund a retirement account.

“For example, let’s say you borrow $30,000 in home equity at a 6% fixed interest rate over 20 years. That will result in repaying over $60,000 total,” Lokenauth adds. “While contributions grow tax-free, investment returns must exceed the interest costs to make it worthwhile. That means you’ll have to count on earning a rate of return on your retirement investments much higher than 6%.”

Remember, too, that all three home equity options come with closing costs that can equate to 2% to 5% of your borrowed amount. You’ll need a generous rate of return on your investments to recoup these closing costs in addition to the principal and interest you’ll have to repay.

Another drawback? You’re putting your home at risk, as you must use your property as collateral to qualify for a home equity loan, HELOC, or cash-out refinance loan. If you fail to repay as agreed, you could lose your home.

Better alternatives

When you ponder the downsides and dangers of funding a retirement account using home equity, it’s little surprise that the experts agree this strategy should be avoided.

“Explore all available alternatives first. Can you reduce expenses, earn more, invest better, or work longer? The best routes to a healthy retirement are saving your earnings, spending less than you earn, and contributing money to tax-deferred or tax-free retirement accounts year after year,” notes Stephen Kates, a Certified Financial Planner and founder of Clocktower Financial Consulting, LLC. 

Ball echoes those thoughts.

“Try to maximize regular income contributions, catch-up contributions if you are over age 50, and other lower-risk investment vehicles. Strategic Roth IRA conversions or employer 401(k) matches could offer safer retirement saving enhancements,” recommends Ball.

The bottom line

Think carefully before proceeding with a home equity decision you may regret.

“Carefully evaluate your financial situation, risk tolerance, and long-term objective. Also consult with a financial advisor who can model tax sensitivity to understand the strategy’s impact on your financial health and retirement planning,” Ball continues.