Why Using Your 401(k) to Buy a Home Could Backfire

As part of a push to address the issue of housing affordability, the Trump administration has floated the idea of letting workers tap their retirement accounts to pay for a home.

In an interview with Fox Business, National Economic Council director Kevin Hassett said, “We’re going to allow people to take money out of their 401(k)s and use that for a down payment.”

There are many unanswered questions about how exactly this program would work, such as what types of accounts besides 401(k)s might be eligible and how much money someone could withdraw. The Plan Sponsor Council of America, a trade group for the retirement plan industry, notes that actually turning this into policy “would likely require new legislation.”

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Would-be homebuyers already have some options for using retirement savings to pay for a home. Under existing regulations, retirement savers are allowed to take up to $10,000 from an individual retirement account, or IRA, for the purchase of a first home without incurring the 10% early-withdrawal penalty that is usually triggered if you take money out before the age of 59 1/2.

This rule applies only to IRAs, not employer-sponsored accounts, but workers with 401(k)s also have another option: They can borrow against them, up to the lesser of either 50% of the vested balance or $50,000.

From a policy perspective, the idea of adding more flexibility to retirement accounts might sound appealing, says Anqi Chen, associate director of savings and household finance at the Center for Retirement Research at Boston College.

“The big thing that I think about is whether making 401(k) savings more flexible for other goals might encourage higher contributions or more participation,” she says.

Americans don’t save enough for retirement as it is, and many don’t even save enough to get the employer matching contribution — essentially leaving “free money” on the table. Chen says workers might be more willing to contribute to a retirement account if they had an assurance that they could tap those funds if needed.

Unintended consequences abound

The problem is that tapping those funds disrupts the process that makes long-term investing a reliable way to build a nest egg.

“You’re losing the compounding power,” says Scott Cole, founder and president of Cole Financial Planning and Wealth Management. “What you can’t replace in the market is time. The longer you can compound, the more power it has.”

While both stocks and real estate generally appreciate over time, there are big differences between the two asset classes, Chen says. Money invested in something like a target date fund within a 401(k) “grows at a steady, very transparent way, whereas for homes, it varies a lot by geography,” Chen says.

Securities are extremely liquid; in other words, they’re easy to sell and turn into cash. Although homeownership is certainly a tool people use to build wealth, home equity isn’t liquid, Cole points out. “You need money that you can spend in retirement,” he says. “And when it does come time to retire, you can’t use that equity unless you sell the house.”

President Trump himself seemed to acknowledge that creating a new avenue for tapping 401(k) assets could derail people’s retirement goals in remarks made on Thursday. “I like keeping their 401(k)s,” he said, because “401(k)s are doing so well.”

This idea would likely lead to other unintended consequences, as well. Suddenly having access to another pool of funds could distort a would-be homebuyer’s budget calculations, Cole adds.

“You probably are incentivized to buy more house than you need,” which could result in higher mortgage payments as well as bigger maintenance and property tax bills.

“The trouble is, when you give people more options, they don’t always know how to make the best decisions,” says Rich Arzaga, principal at the Real Estate Whisperer Financial Planning and adjunct professor at University of California, Berkeley Extension.

Based on his experience with real estate investing, Arzaga observes that people’s emotions can become very involved when it comes to home-buying. “The real concern I have is when people see the American dream in front of them and all it takes is $50,000 or $100,000. They get confused they get emotional, [and] when people get emotional about things, they don’t make very good financial decisions.”

There’s another serious issue, he adds: Sinking a big chunk of your retirement funds into a home creates significant concentration risk.

“When you take $100,000 and put it into a house, all of a sudden you have a highly concentrated position. You have a lot of equity in one asset,” Arzaga says. Just like you wouldn’t bet your nest egg on the performance of a single company, you don’t want your future financial security determined by the vagaries of the real estate market.

Trading your nest egg for a mortgage is a risk that could very easily backfire, he cautions. “If you’re looking at this from a retirement planning perspective, it is better for most people to leave the money in the 401(k) and let it grow.”

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