Question:   Should I take a 401k withdrawal in order to buy a new house?

Answer:      The recent trends in the housing market have tempted many to make a withdrawal from their 401k under the “hardship withdrawals” heading allowed by the IRS.

Typically an early withdrawal can be made from your 401k for hardships, including the purchase of a primary residence. However, the fact that you can do something doesn’t mean that it’s a good idea, so read the following for some specific 401k advice.

Making a withdrawal from your retirement account to fund a down payment on a new home may sound like a good idea at first, especially in a buyer’s market and when you are low on cash. However, when you take an in depth look at the 401k rules you will see a number of reasons to leave those funds right where they are.

After all, this is the money you’ve been carefully saving for retirement, not for the purpose of buying a new home. There are a number of better ways to save for a down payment that you can liquidate without nearly the damage caused by an early 401k withdrawal.

A short-term investment account, a money market account or even a plain, old-fashioned savings account would be a better option. All of these accounts are meant to be liquidated for spendable cash quickly and without penalties for the owner.

Conversely, a 401k withdrawal is very costly to the owner. First, you instantly lose whatever amount you withdraw from the principle investment of the account. It will no longer be earning compound interest in your retirement account. Your entire account will earn less interest income because the total investment is now reduced.

Next, you will have to pay taxes on the amount you withdraw. Taxes must be paid the same year as the withdrawal, and will most likely be taken out automatically by your employer.

Lastly, you must consider the steep early withdrawal fees. Between the tax load and fees, you stand to lose around 40% of the amount withdrawn before you ever see a penny.

After taking these details into account, it’s plain that making a 401k withdrawal under these conditions is probably not a wise financial move. Even the temptation of a buyer’s market may not fully justify the losses that your 401k balance will suffer from an early withdrawal. You lose more taking an early withdrawal than if you were to take out a loan at 15% - which just adds to any existing debt you may have.

The marketplace offers many new first-time home buyer programs that may make much better sense than raiding your retirement account. Remember, one of the reasons you chose to invest in a 401k was to make sure that money would be there, safe and secure, when you retire.

Stick to the plan you signed up for. At retirement age, you’ll be glad you did!

Check out our free money saving tips in Savings Fitness, a free guide to your money and the health of your financial future.

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