Using 401k as a first time buyer.?

Question

I am a young student and started my 401k last year after being told by a relative that I will be able to use the money to purchase a home without taxes and paying the 10%. I am not really sure about the rule exactly of how 401k works. It really wouldn't affect me as much in the future since im still in my young 20's. I will have time to get that money back up for retirement in no time.

So exactly what should i expect as far as fees goes? Is there any benefit to being a first time home buyer? I also dont mean to just borrow, it will be way too difficult to pay mortgage and 401k at the same time.

Thanks

I have 401k.... I have a decent job, just because I'm young it doesn't mean I can't have a 401k. I got one through work.

As far as IRA...

Can I transfer my 401k to IRA in order to buy a house?

I am not buying one anytime soon I am just preparing. Unlike my fellow college students I think a little bit further down the road....

Answer 1

Leave your 401k alone. Yes, you may be young but no reason to go backwards in your retirement savings. Besides, what you borrow from your 401k has to be paid back.

ROTH Iras, on the other hand, let you take out what you contributed tax and penalty free if you've held them 5 years (not sure on the exact year limit).

There are many state and federal programs to help first time home buyers. Check at your local bank or mortgage company or google your state.

I know that my credit union offered a "first time buyer" deal too.

If you can't fund both the house and the 401k at the same time then reduce your contributions to the 401k for a while until your salary goes up. Try to put in at least to the company match limit.


Warning: 401(k) loans are hazardous to your wealth
Borrowing from your 401(k) plan should be your last solution, not your first, when you need a loan fast. Here's a look at the pros and cons.
By Ginger Applegarth

It sounds so simple. You need some quick cash because of a financial emergency and you decide to borrow from your 401(k) retirement plan. After all, it's your money and the interest and principal you pay goes back into your account. But as with most financial issues, it's not as simple as it sounds.

In fact, for most people, borrowing from a 401(k) is not the best solution.

The rules:
If your 401(k) plan allows loans (most do), you can borrow up to 50% of your vested account balance or $50,000, whichever is less. You usually have a maximum of five years to repay the loan, unless you are borrowing for a first home, which allows a longer payback.

Before we get into the pros and cons, one caveat up front: If you've got a financial emergency, and your only choice is between borrowing from your 401(k) plan or pulling the money out in a hardship withdrawal before you're age 59 1/2, it's a no-brainer. By all means, borrow the money. That's because there is no penalty on borrowing, but there is a 10% penalty on early distributions.

Now, let's go through the pros and cons of borrowing from your 401(k).

The pros:
There is no credit check. You don't have to apply for the loan, and you can make plans knowing that you will get the loan.
There is a low interest rate. You pay the rate set by the plan, usually a couple of percentage points above the prime rate.
It provides a great return. If your money market account is earning 3% and you pay yourself back at 6% or 7%, it looks like a good deal.
The interest is tax-sheltered. You don't have to pay taxes on the interest until retirement, when you take money out of the plan.
It's convenient. Some plans only require you to make a phone call, while others require a short loan form.

The cons:
About that credit check: Of course there isn't one. You're not borrowing anything. You're spending your own money.
You're losing interest. The net effect is that you have less money to invest and to earn interest. The money you borrow -- or take out -- of your retirement plan no longer appreciates in value from interest, dividends and/or capital gains in conjunction with the rest of your investment portfolio. Remember that you aren't really borrowing. All you are doing is using money from one account, such as your checking or savings account, to repay the money you borrowed from your 401(k). And when you take money out of that checking or savings account, that money loses interest, too.
It's not tax-sheltered money anymore. Whether you repay the 401(k) loan out of your salary or from a bank account, those payments are all made back into the 401(k) with after-tax dollars. So, let's say your monthly interest payment is $300 and you're in the 28% tax bracket. You'll have to make $416 in gross earnings to make the $300 payment. Then, when you retire and take withdrawals, you pay taxes yet again.
Unless you repay the loan, it is considered a premature distribution. You would owe federal and state income taxes as well as that 10% penalty if you are under age 59 1/2.
The loan isn't tax deductible. It's considered a consumer loan, so there is no tax advantage.
It affects your psychology toward retirement saving. If possible, your retirement money should sit untouched until you retire. It's too easy to get in the habit of dipping into your 401(k) instead of saving for things you need along the way. Keep your 401(k) in a loan free zone.

The bottom line:
It's better for most people to take out a home-equity loan if they're homeowners. In most cases (unless you're borrowing more than the value of the home), you can deduct the interest on your taxes.

Another option is to use money currently sitting in a low-interest rate savings account or money market fund.

Answer 2

I think you mean you started an IRA, not a 401k.

You can't just open a 401k; they are offered through your employer--and you usually are only eligible for one if you are a full-time employee. Plus, the rule you are citing about using the funds for a first home tax/penalty free is true of IRAs. So since you say you are a young student, you likely do not have a 401k. You probably opened an IRA.

Here's the deal with IRAs:

1. Using an IRA to save for your first home is a good idea because you can save for your home and not pay taxes on your gains along the way (although it's even better to use it to actually save for retirement).

2. There are two types of IRA--Roth and Traditional. You should have a Roth because of your age and low tax bracket. You don't need the tax decuction a Traditional IRA offers. So I hope you opened a Roth; if not, you really should roll it over into one.

3. You can take your Roth IRA contributions out tax and penalty free anytime--because you already paid income taxes on the money before it went in (unlike a 401k or Traditional IRA). You can take out your contributions AND the earnings on them tax and penalty free for your first home, to pay for college tuition, if you get disabled, or in case of other special circumstances.

As far as home buying goes, you can expect to pay 3-5% of the value of the home in closing costs. You will pay a lot for property taxes and insurance, too (and HOA dues); get quotes on that before you start looking for a house--you might have to lower your price range because of those other high monthly costs.

Do not buy unless you can afford a 30 year fixed rate mortgage. Don't get sucked into an ARM or some other variable rate mortgage! You should not let your housing costs (mortgage, insurance, taxes, HOA, utilities) exceed 40% of your income!! Trust me, you will want to have money to spend on other things--whether it's saving for retirement, vacations, going out, or buying that new pair of shoes. Don't be a slave to your mortgage!

Answer 3

If you borrow from 401(k), you will pay yourself back with interest. If you started your 401(k) last year, you probably don't have that much money in it. And if you have difficult time paying morgage and 401(k) at the same time, why would you want to do this? Keep on putting some money in 401(k), and save some money for the house to buy later. People think they are rich, when they have just 20 to 30K in the bank. It really is nothing with current economy, and current housing prices.

Answer 4

I'm afraid you were given bad information. If you are taking money out of your 401(k), it will be a loan. You will have to repay it or you will have to pay the 10% fee plus the taxes.

From the IRS:

5.3 Pensions and Annuities: Distributions, Early Withdrawals, 10% Additional Tax

Can I withdraw funds penalty free from my 401(k) plan to purchase my first home?

If you are under the age of 59 1/2, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a 10 percent additional tax on early distributions from qualified retirement plans. However, depending on the rules for your 401(k) plan, you may be able to borrow money from your 401(k) plan to purchase your first home. Your plan administrator should have written information about your particular plan that explains when you can borrow funds from your 401(k) plan as well as other plan rules.