Taking full advantage of 401k match when you don't want it

Question

Suppose you have $100,000 "locked" into a traditional IRA.

You work at an employer that will match 50% of your 401k contributions (any amount up to 18K limit). Vesting is immediate.

Suppose you want to buy a house and would rather put funds toward a downpayment than contribute the full 27K (after match) to your 401k this year.

You are faced with two options (and a spectrum in between that I'm ignoring for now):

1. Make no 401k contribution; put the 18K towards the down payment. Let's assume your tax rate is 30% so you have 12.6k after tax for your downpayment. Net effect: personal account +12.6K, retirement: 0.

2. Make full 18k contribution and receive 9k match. Withdraw 27K from the IRA: pay 30% tax + 10% penalty. Net effect: personal account + 16.2K, retirement: 0 (though IRA is down 27K and 401k is up 27K).

In this scenario between the two extremes, option 2 makes more sense. Am I missing something? Also, I realize you can pull 10K out of your IRA for a house downpayment without penalty but I'd like to ignore that for the purposes of this comparison.

Answer 1

The only thing you are missing is that you can borrow up to 50% from a 401k's net value at very low interest rates, where you cannot borrow from a traditional IRA.

Therefore, after contributing to your 401k with that match, assuming no adverse market fluctuation, then from your 27k value 401k, you could borrow 13.5k, which puts you ahead of option 1, close to option 2, while keeping a growing balance of 13k in your retirement.

Year 2 will be even better. Assuming you stay employed, but your mortgage assumes this at much greater risk, so we can be just fractionally as optimistic and add the possibility that you get an incremental pay raise, which supports paying off your 401k borrowings quicker or at no consequence to your finances compared to now. (sidenote: if you change jobs you likely have to pay off the 401k loan immediately.)

Some plans also allow for moving traditional IRA assets into traditional 401k. Then you could take advantage of everything mentioned here up to $50,000 with no penalties. The max you can borrow from a 401k is $50,000.

Answer 2

From what I can tell, your math is correct, and in this scenario, given the choice between the two, taking the 401K match and then incurring the penalty does appear to be the better choice.

One tweak I might make is to lean towards withdrawing right back out of the 401K instead of from the IRA. The penalty is the same either way and typically the costs and fund choices are more advantageous in an IRA compared to a 401K. (But you can only do that if you quit your job, since you aren't allowed to withdraw your 401k funds while still employed at the company.)

You can avoid the tax and penalty by taking a loan against your 401K (up to 50% of your total balance or $50K, whichever is lower). However, if you fail to pay the loan back within 5 years, you would likely owe the tax and 10% penalty (which would be fine for this comparison), however, you also run the risk of being unable to further contribute to the 401K plan after that, though I have no idea how often that last part of the rule is enforced. In this case, if you can't pay off the loan in time I would then choose to take it out of the IRA. At least this way you get 5 years to try to avoid the tax and penalty.