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Ask Dr. Don

Time to get out of my retirement plan?

Dear Dr. Don,
Would it be a good idea to take money from my retirement plan to build a house in this sluggish economy? I have lost about 40 percent over the past year or so. I know that there will be penalty and taxes of about 32 percent, but is getting out now worth it to invest in home equity?

Dear Pat,
Watching your account balance decline in your 401(k), 403(b) or IRA account is a gut wrenching experience. You think, if only I had been smart enough to see that the stock market was heading for a fall. If it helps, you weren't alone.

Let's say you had $100,000 in a 401(k) account and you watched that account decline to $60,000. Paying income taxes plus a penalty tax of 10 percent for an early withdrawal, assuming that your 32 percent is correct, would result in you having $34,800 to invest in a home.

I've put together an example that compares your investment in real estate to just holding on to your retirement account over the next 20 years. In it I assume that your home appreciates in value by 3 percent annually while a stock portfolio appreciates 9 percent annually.

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The stock appreciation value is quite conservative for a well-diversified portfolio of stocks. After all, the Standard & Poor's 500 Index, an index of the largest capitalization stocks in the U.S. market has averaged 12.7 percent annual returns in the 10 years ending Sept. 30, 2001.

We'll assume that you would pay the same in rent ($903 a month) as you would pay in mortgage payments. Another assumption -- at the end of 20 years, you're in the 28 percent tax bracket and you'll have to pay taxes on the profits in your retirement portfolio (in this case, $94,154 in taxes). 





Purchase price:



Down payment:



Loan amount:




Loan rate:



Monthly payment:




Twenty years later:




Appraised value based on 3% annual appreciation:



Loan balance:



Home equity:



Note: The retirement scenario assumes that you rent and that the rental expense is the same as your monthly loan payments plus taxes and insurance for the home purchase scenario.

Now, I realize that these figures are all pie in the sky calculations.  You don't know how your real estate investment will appreciate over time any more than you can know how the stock market will do over time. 

My point is that keeping that $25,200 working for you in your retirement account vs. paying it out to the IRS in taxes and penalties, can mean a lot for your future retirement.  You have to weigh how close you are to your planned retirement, and how comfortable you are with the long-term prospects of real estate or the stock market before you decide which decision is right for you. 

Get professional help from a fee-only Certified Financial Planner if you can't decide.  The CFP Board of Standards can help you with finding a financial planner in your area and how to choose a planner.

-- Posted: Oct. 15, 2001

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