Consider Taxation Before Using Your 401K For a Down Payment

by Tyler Osby on September 15, 2009

401K Loans Can Be Easy to Get

As downpayment requirements increase, anecdotally, home buyers are tapping 401(k) plans for extra cash.

Classified as a “hardship withdrawal”, loans against your retirement funds can be cheap and simple.

  1. There’s no credit check or approval process
  2. There’s only a small set of paperwork
  3. Money can be available in as little as a day

But just because you can get access to your retirement money doesn’t mean that you should.  401(k) withdrawals should only be made after careful consideration. 

You Could Be Taxed Twice On the Same Money!

There are some serious negatives, specifically with respect to taxation. 

If you open a 401(k) loan and don’t repay according to the loan terms, the withdrawal ends up getting taxed as income, plus a 10 percent penalty for people under 59 1/2. 

That’s a stiff penalty.

But, even if you do repay the loan on time, you’re still getting leaving yourself subject to double-taxation. 

  • Taxation #1 occurs when the loan is repaid using post-tax dollars
  • Taxation #2 occurs upon final withdrawal at retirement

Furthermore, when you borrow against a 401(k), you assume the opportunity costs of having that money out of the market.  Since March, the Dow Jones Industrial Average is up 44 percent.  If your 401(k) was empty, you’d have missed those gains forever.

Taking a loan against a 401(k) isn’t necessarily a bad idea, there just may be better choices. If you’re planning to withdraw from your 401(k) to make a downpayment on a home, talk with a qualified financial professional first.

You can never have too much good information.

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Tagged as: 401(k), Down Payment, Hardship Withdrawal, Retirement

{ 1 comment… read it below or add one }

Jack September 16, 2011 at 4:07 pm

Double taxation? Seriously? Any loan you take out is repaid in after tax dollars. This double taxation idea with 401(k) loans is complete bunk. Please do your research and then revise this article accordingly.

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