disadvantages of saving for home down payment through 401k or 457k

Question

I've been toying around with the idea of setting aside money via my 401k specifically for use as a down payment on a house. To be clear, I do currently put 9% into my Roth 401k option and my employer matches this contribution, this is the maximum match that I can receive. My question is regarding contributing an additional amount on top of this contribution that I intend to use specifically for a down payment on a home at some point in the future. I live in MI, USA and am under the impression that you are allowed to withdraw up to 10 thousand dollars with little to no penalty for the purchase of your first house from your 401k.

The main benefit I hope to gain from this is convenience for myself, as the money would come out directly from my check and I won't have to worry about it until it's time to buy a house. There is also potential for slightly higher interest then a savings account, but that comes with potential for loss. I do have the option of putting the money into a separate 457k so I can keep my house money and retirement money separate easily enough.

So then, is there any massive disadvantage to placing extra money into a retirement account and planning to withdraw it at some point to aid in buying a house? And is there any benefit of using the 401k over the 457k to save for the down payment?

Answer 1

There are several disadvantages:

1. You cannot generally withdraw from a 401(k) while you're still employed at the same employer.

2. When you do withdraw, then unless you roll it over, you pay tax on the whole amount based on the marginal tax rate you have that year. If it comes on top of your regular salary, the whole withdrawal will be taxed at the higher marginal rates.

3. You will also pay extra 10% penalty for the withdrawal. For home purchase you can take out up to $10K without the penalty, I doubt that would be enough for downpayment.

There are probably more, but these are the major ones I can spot.

The same goes to the 457(k), except that those don't have the 10% penalty.

Answer 2

While you can borrow money from a 401(k) for your home down payment, there are disadvantages, including but not limited to:

• The 401(k) is designed as a way to save for retirement. Smaller contributions and balances (due to the loan) in your account will add up and significantly reduce your balance over time.

• If you lose your job you will have to pay back the loan quickly, within 60 days.

• Interest on the 401(k) loan is also not tax-deductible, even if you're using it to pay for a home.

My advice: max out any employer contributions to your 401(k) because it's free money. After that, extra savings for a house should be in a separate account.

Answer 3

In addition to the already good answers you also want to consider your time horizon. Unless you are looking out 10+ years, building your down payment in an account that is invested in the market is probably subject to too much market risk. Are you willing to delay purchasing a home by five years if the market turns down at the wrong time?

A better option is to just use a savings accounts. To avoid spending the money, you can open a dedicated account. Separate savings account for a special purpose are s common feature at credit unions and probably are available at many regular banks as well. Then for funding the account, many employers allow you to split direct deposits amongst multiple accounts, so you will just need to provide the routing number and fractional amount of your paycheck for that account.