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-- Posted: Oct.26, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

How do I use my pension to buy a house?

Dear Dollar Diva,
My wife and I are young professionals looking to purchase our first home. We do not have any cash saved up and we do not have family members from whom we can borrow. We would like to use the money from my 401(k) or my wife's 403(b) retirement plan for the down payment.

We just moved and started new jobs and could rollover our 401(k) and 403(b) retirement plans if needed. What would be the best thing to do?

The best thing to do is be grateful you don't have family members to tap for the down payment on your dream home -- those loans carry a lot of baggage, financial and otherwise. Two bright, competent young adults like yourselves are certainly capable of figuring out how to buy a home on your own.

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The Diva doesn't like the idea of taking money from your retirement plans, even if you do avoid the 10 percent early withdrawal penalty as first time home buyers. Here's why:

  • The distributions are taxable. At 28 percent, a $10,000 withdrawal puts $7,200 in your pocket, and $2,800 in Uncle Sam's.
  • You gain $7,200, but you give up tax-deferred growth and earnings on $10,000 of retirement money. Using a 10 percent rate of return over 30 years, that's goodbye to $174,500. If you both withdraw $10,000, say au revoir to a whopping $349,000. The Diva thinks it's a lousy trade-off.
  • Adding a chunk of taxable income to your tax return could have some unexpected results, such as reducing or eliminating your deduction for student loan interest. See the Diva's "How does a 401(k) lump sum withdrawal work?" for other potential tax triggers.
  • Homeownership is expensive. If you don't have the discipline to save up for a down payment, what are you going to do when you have to replace the roof or the central air conditioning system?

Rent or buy

You've just moved to a new place. How well do you know the area? Are you pretty sure you'll be living there for more than a year or two? When you close on a new home, expect to pay thousands of dollars up-front for a title search, title insurance, survey, appraisal, recording fees and loan origination fees. You want at least three or four years over which to amortize these costs.

To help you determine if renting would be a better option for you, plug your numbers into a rent vs. buy calculator. The Diva did a little Web surfing and found a couple for you to try out: Quicken's "Rent vs. Buy" calculator and HouseHunt's "Buy vs. Rent Calculation."

Tapping into your retirement savings

If you've done everything possible to save up for a down payment, like living in a cheaper apartment and cutting down on spending for non-essentials, but you still need to tap into your retirement funds to start the home-ownership ball rolling, so be it.

Check with the plan administrators of your 401(k) and 403(b) plans to find out if you can get penalty-free distributions as first-time home buyers. If you can't, have them rollover the money directly into your IRA accounts, and take the penalty-free distributions from there.

Here are the rules for taking penalty-free early distributions as first-time home buyers:

  • Each of you is allowed to withdraw up to $10,000 to buy a new home; that's a total of $20,000.
  • The money must be spent on costs related to the purchase of a principal residence. It can be used for the down payment, settlement charges and closing costs.
  • "First-time home buyer" means you and your wife did not own a principal residence at any time during the two years prior to the purchase of the new home.

For more details on penalty-free distributions for first-time home buyers, read IRS Publication 590, Individual Retirement Arrangements (IRAs).

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