My wife and I have been renting for many years and we think it's time to buy our first home. We live in Westchester County, New York and are looking for a home in the $450,000 – $475,000 price range.
We both have 401(k)s – my wife has about $450,000 in her 401(k) and mine has $200,000.
My question for you is, would it be a bad idea to clear out my 401(k), which is the smaller one, to put down a down payment on the house? I know I would be taxed for this but hopefully I can cover that. I am over 59 years old and am hoping to retire in six years. My wife can withdraw a little beforehand.
Thanks very much,
Waiting in Westchester
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I don't like to tell readers no. It is clear that buying a home is important to you and your wife – of course owning your own home would provide a sense of security and stability as you enter your retirement years and adjust to a steady income. But as the Rolling Stones cliché goes, we can't always get what we want.
I presented this hypothetical scenario to financial planners. Almost everyone warned against it across the board. Some were more outspoken than others.
"Here's my expert opinion on the matter: No, no, no, no, no!" said Peter Palion, founder of Master Plan Advisory, a financial planning firm based in New York.
Like many other potential home buyers, you may be seeing mortgage rates rising and feeling the need to lock in a lower rate while you still can. And to some extent, it's arguable that guaranteed savings in the form of lower interest rates are worth missing out on the potential growth of that money through investing. However, the calculus changes as we age and approach retirement.
"While rates and growth are not guaranteed, financial planning models would show that using one-third of your retirement savings to buy a new home early in retirement would result in less disposable income in retirement, minus mortgage payments," said Sean Pearson, a Financial Planner at Ameriprise Financial Services in Pennsylvania.
You are at a point in life where the goal should be to maximize your retirement savings. One reason, Pearson notes, is that these remedies will come in handy as you and your wife's health deteriorate. You would like to have sufficient funds to cover your living expenses in the future as well.
""Financial planning models would show that using a third of your retirement savings to buy a new home early in retirement would generate less disposable income in retirement."”
This also applies to your own home. Sure, the down payment is the first hurdle, but later you'll have to pay taxes and child support, even after the mortgage is paid off. So what would happen if you didn't have the funds to cover them well past your retirement age? I doubt you or your wife want to risk foreclosure or live in misery.
I am also concerned that you are underestimating the potential tax impact here. Some 401(k)s allow distributions while you're still employed — in some cases without the typical 10% tax penalty if the person is older than 59.5 years. Nonetheless, any distribution from your account would be taxed as income. Adding $200,000 in income through your retirement account would easily put you in a higher tax bracket — a very expensive proposition. And really, once the taxes are factored in, you wouldn't really get $200,000 anyway.
Some financial planners suggested that you could take out a 401(k) loan. In this way, you would essentially be borrowing money – and you would have to pay it back with interest. Such a loan is not considered a taxable event. "They could borrow up to $50,000 each this way, which should go a long way toward providing a down payment for a couple who have just a few years until retirement and a $600,000 nest egg," said Paul Winter, a financial planner based in Utah.
But again, withdrawing money from your retirement accounts for a down payment has a high opportunity cost — it probably won't yield as great a return when invested in a home as it would by investing in the market.
Ultimately, if buying a home will save you money in the long term, you should consider paying a lower down payment, even if it means paying for mortgage insurance. You don't need a 20% down payment to buy a home, and you could focus on paying off the principal more quickly after the purchase by making additional payments to cover the additional cost of mortgage insurance.
If you and your wife haven't, I would sit down with a financial advisor to set your retirement goals. You could do an analysis of your current retirement savings to gauge how far they will go — and from there you can both decide if buying a home makes financial sense. You both deserve a peaceful, fun-filled retirement, and being conscious about how you spend your money over the next few years can help ensure that.
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