Can I use my 401-K to purchase a home?

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Welcome to the Ask Ralph Podcast where listening to an experienced financial professional with over 30 years of experience can help you make sense of confusing questions, current headlines and industry trends about taxes, small business, financial decision making, investment strategies, and even the art of proper budgeting. Ask Ralph makes the complex simple by sharing his real world knowledge from a Christian perspective with all things financial.

Now here's your host, Ralph Estep Jr.

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Welcome to the show tonight. I am so happy you chose to join me. If you've got a question, post it right in the chat or feel free to make your comments. I'm going to start with a listener question I got this week, and after I cover that topic, I'm going to come back to answer all your questions. So feel free to ask them.

So let me start by asking you this simple question. Have you ever felt the weight of watching home prices soar while your dream of homeownership seems to slip further away? A lot of people are dealing with this right now. What if I told you there might be money sitting in your retirement account that could turn that dream into reality?

Listen, before you reach for those 401(k) funds, let's explore whether using a retirement savings for a home purchase is really a wise decision or indeed a costly mistake. Well again, thank you for joining me. This is your weekly opportunity to get your questions answered. As I said, feel free to ask your questions in the chat.

Do me a favor, put a Q and a colon and ask your question. Now I see it right away. Feel free to comment and listen, I'm going to tell you about something very special that's going on. I'm going to encourage you to take our show survey. We released this about a week ago. And it takes about five minutes, even less than that.

But here's the really cool thing. Everybody who goes in and does the survey is going to be put in a $250 Amazon gift card drawing. So one person who fills out that survey is going to win 250 bucks. Now here's the deal. I need your responses by midnight on December the 10th, because I'm going to draw the lucky person on December the 11th.

So I hope you really takes time to do it. And you get to the survey by going to askralphpodcast.com/survey. Again, I'll answer the, I'll give you the address. Again, it's askralphpodcast.com/survey. And I see Pokémon guy. I got your question, and I am going to handle that question right after this.

So let's get right to our listener question tonight. And this listener question comes to us from Isabella. And this is what Isabella had to say. She said, "Ralph, I'm Isabella from Tennessee, and I'm writing with tears in my eyes. Last night, my seven-year-old daughter, Emma asked me, mommy, when will we have our own house like my friends? I'm tired of moving every year. The truth is, my husband and I have been renting for 8 years, and each rent increase feels like another dream being crushed. We've managed to scraped together $10,000 for a down payment, but in today's market, it feels like throwing a pebble at a mountain. We have about $85,000 in our 401(k)s, and every night, I lie awake wondering if we should use it to finally give our daughter the stability she deserves.

Our current rental's owner just announced they're selling, so we're facing yet another move. We're both 35, and watching our daughter pack her toys into boxes for the fourth time is breaking our hearts. The thoughts of using our retirement savings terrifies me, but so does the idea of telling Emma we have to move again.

What's your biblical perspective on this? How do we balance being good parents today with being financially responsibly for tomorrow?" Let me just tell you, well, Isabella, that's rough. I can feel the emotion in your letter. When I got this this week, I said, well, that's going to be a great topic for our Tuesday night show.

And you're in this heart wrenching situation. I get it. You're trying to balance your finances and your emotions. And listen, that's never easy. It's never easy to balance those two things. And I understand it. You've got this desire for stability. You and your husband want to give Emma that home that she can call her own, and she certainly deserves that stability.

But I'm going to tell you before you use that 401(k) money, let me share some ideas with you. And first thing I want to do is I want to go to our Bible verse. You know I always try to start with scripture. And Isabella, I found this when I thought this was perfect and it's from the book of Proverbs 21:5. And it tells us, "The plans of the diligent lead surely to abundance, but everyone who is hasty comes only to poverty." That's a pretty direct question. But Isabel, your question requires this diligent consideration. As you said, you don't want to make a hasty decision. So you might be asking, Ralph, how do we make, how do we handle this difficult situation?

Let's start talking about it right now. I'm going to tell you about a couple I met several years ago. I always try to put things into terms of other people I've dealt with. And listen, this couple was much like you and your husband, Isabella. They had come to see me for help. They were wrestling with that same decision.

They had been through rental after rental, and they wanted to have that stability of owning their own home. And they too had those retirement funds. They had that money they were putting away for their golden years, for their retirement times. And they started thinking, they say, I might consider using these funds for their home purchases.

Somebody else they knew had done it. And I'm just going to say, fortunately, they made the right choice and met with me. They came in, they sat down in front of me. They told me about their desire to buy this house. They already had one picked out. It was the perfect place for them, was perfect place for their kids.

And we discussed the options. And we came to this point where we started talking about, we need to figure out how to, you know, how to navigate this intersection of family, faith, and finances. And that's really what it comes down to. This decision is one, if you're a faithful person, is one that comes down to faith, it comes down to family, and it comes down to finances.

And let me share what I shared with them. I'll share this with you tonight. So let's start with the basic understanding of how you would access your 401(k) plan. And see, you got to remember this. Okay. Your retirement account is not just a savings account. It's not simply something that's in a savings account at the bank that you can go tap when you want it.

These retirement accounts are carefully designed, they're a tool for your future security. That's why they're created. So here would be your two options. Let's say you decide after listening tonight or meeting with somebody, and I highly encourage you to meet with somebody. You say, all right. What are my options, Ralph?

There really are two options and it depends on your particular 401(k) with your employer, whether this one even applies. But the first one I'm going to talk about is what's called a 401(k) loan. If you're going to take money from your 401(k), I'm going to start by telling you this is the better option and what this will do, most 401(k) plans will allow you to borrow up to 50 percent of the 401(k) balance or $50,000, whichever is less. So you're not going to be able to borrow all of your money, but generally they'll let you borrow up to half of it. So if you've got a hundred thousand dollars in your account, they generally will let you borrow $50,000 or that 50%.

And here's the thing. You've got to repay that loan over five years. So you've got to be thinking about this. If you're going to use this money for a retirement, or excuse me, for purchasing a home for that down payment, you're going to need to have two payments in mind.

You're going to have that new mortgage payment, and you're also going to have this repayment to your 401(k) plan. Now, the interest they're going to charge you gets paid back to your own account. So you're really borrowing on yourself. Normally these payments are deducted from your paycheck. And the best part of this from a tax perspective is there is no tax penalty as long as you follow the rules. You just got to be careful about one little tricky thing. If you have a 401(k) loan and you lose your job, or you decide to leave your job, generally, you've got 60 days to pay that back. So think about that for a second. Let's say you borrowed that $50,000 and then a year from now you decide, you know what?

I've got this other job opportunity. That's really a lot better than the job I'm in now. Well, all of a sudden, you're going to have 60 days to pay that back. And if you don't pay it back, it becomes a distribution. And then we'll talk about taxes. So that's really option one is do that 401(k) loan. Your second option is what we call a hardship withdrawal now, or just a withdrawal.

You could call it that. But this is not a loan. What this does is it permanently removes money from your retirement account. It just takes it out. You go to your HR person, you go to whoever handles that and say, look, I want to take money out of my account. Again, it's not a loan. So there are going to be immediate tax consequences.

Let me tell you what those look like. Right off the bat, whatever the amount is you take, you're going to pay a 10% what the IRS calls early withdrawal penalty. So let's say we're doing that $50,000. You're going to pay $5,000 of that money right away in that early withdrawal penalty. Of course, there's no need to repay this.

You're not going to have to pay the money back, but that permanently takes the money out of your account. So it's not just that 10 percent penalty though. It's also going to be taxable income to you. So you're going to have to pay federal and maybe state taxes on that. And I'll talk about some real scenarios here in a few minutes if you were to take that money out. And the big picture thing you got to be thinking about, we're talking about the money for golden years. If you take that money out, it's going to permanently reduce your retirement savings. It's not going to be there to grow anymore. So you might be saying, Ralph, how do I even make this decision?

And I'm going to tell you about somewhat I call perspectives on making this decision right now. I want to try to help you make that decision. The first thing you've got to think about is what's called what I call the family impact perspective. Because if you decide to do this, whether you borrow or take the money out as a distribution, you are really trading tomorrow's security for today's stability.

What do you mean by that Ralph? What I'm saying is you've been putting this money, been squirreling this money away in this retirement plan for that time when you go to retire. That's what I call tomorrow's security, but maybe you're making a decision. Well, Ralph, that's great, but I need stability today.

I need a place to have for my family. So you're trading that security later on and adding it for stability today. And that's the real whole point, isn't it? I mean, think about it. That's the whole point to this whole discussion. And listen, I have seen at my practice, I've been doing this for over 30 years now, and I've seen families struggle with this.

I've seen husband and wives almost break up their relationships over this because one party wanted to do it, the other didn't. And look, I'm going to tell you right now, this is not an easy decision, but I think one of the keys, as I talk about this family impact perspective is understanding that strong family relationships contribute significantly to our overall wellbeing.

They just go hand in hand. This is just the truth. You got to understand that the relationship with your family and I've broken this. I'll talk about that in a second. Like I didn't do a good job of this when my kids were young, but those two things go hand in hand. So you've got to have this goal.

You got this goal, this plan of trying to balance that immediate family need. They need a place to live. They need that stability with that long term security. And see, I made this mistake myself. When my kids were young, I decided one day I said, you know what? We should move to the beach. And I didn't think about the impact that was going to have on my young children.

I don't remember exactly how old they were, but they were pretty young, you know, and uprooted them from their school, uprooted them from their friends, all because it was my decision. I want to go live at the beach. That's what I wanted to do, but I didn't think about the impacts. That's why I say you got to study that impact and what that's going to look like.

You know, I thought going to the beach would be great because we'd all enjoy the benefits. We'd all have the time to go out on the Santa. I remember we had one of those four-wheel drive vehicles. We go out on the surf. We actually had a pontoon boat. We had a great time. But then as my kids got older, I started to realize what that did as far as that stability.

You know, I wanted to live at the beach. But I didn't think about the impact on my kids. So that's one of the things you got to consider, and you've got to really do that. So the second perspective, I think you've got to really consider is the communications factor. And this is where Ralph broke it again.

You've got to have an open family discussion about using those retirement funds. Now, my situation wasn't tapping into retirement funds. It was just the idea to move. But if we add that layer onto it, that family discussion, you know, do you want to have that stability now? Do you want to trade off that stability?

Now, listen, if you've got toddlers, this isn't a family discussion to have with toddlers, but this is one of the things that you've got to have husband and wife. If you're married, have this discussion about what does this look like short term? What does this look like intermediate term? And what does it look like long term?

Cause look, this is not just a financial decision. People come to see me all the time. I say, well, which hat do I need to put on today? Because oftentimes it's not just a financial decision. Like I said, this is a family decision, and it affects everyone's future. You've also got to consider this perspective, and a lot of people don't think about that, and that's the work life balance consideration.

You know it's hard to establish healthy boundaries between financial goals and family needs. And I found this quote and I thought this was ideal. I don't know who said it, but it's so true, and I've learned this as I've gotten older. And this is what it says. It says "Family is not an important thing, it's everything." Let me say that again. Family is not an important thing, it's everything. Now with that said, you've still got to balance that family stability with making the best financial decisions. And listen, this is a tough balance, and I don't have all the answers. I just wanted to share with you some ideas.

Well, let's look at some real-life scenarios. We'll call this one scenario number one, and this is what we call the Martinez family. So Marie and Carlos Martinez, they access, so in their particular case, they took $45,000 from their 401(k) to make a home down payment, which that was their decision, which is fine.

And the immediate cost to them was $4,500 in early withdrawal penalties. They didn't do that loan. They decided I don't want to have that loan. I just want to take the distribution. We'll take our tax hits, and it costs them $4,500 in early withdrawal penalties. And like I said, that's just the 10 percent penalty. We'll add to that this then add another $11,250 in federal taxes. And don't forget about state taxes. If you have a state that taxes income, you're going to pay that also. So think about this. So they took $45,000. They lost $45,000 right away with a penalty and almost let's say $11,000. So they lost $16,000 of the 45 right off the bat in penalty and taxes.

And you say, Ralph, that's horrible. But let me tell you the worst part. They also lost 25 years of growth of that money. If they had left that $45,000 in there, guess what they would have had after 25 years. That $45,000 would have grown to $280,000. So it's not just the tax costs today. It's not just the penalty today.

It's that potential growth that you're taking out of this equation. They basically lost $280,000 of that future security. And unfortunately, the mortgage payment was higher than they expected. They didn't anticipate all the extra costs that went in it. They ended up working extra hours to compensate for that.

And guess what? All of these decisions they made, they, it impacted their family time, and it impacted that work life balance that they so hard to try to do. So this is the scenario of, I don't know if you want to go down this road. Think about that. $45,000. You took it out but look at all the cost of that.

Well, let's look at scenario number two, and that's what I call the Thompson approach. Now this particular client, they kept their retirement intact. They didn't even touch it. They didn't take a distribution from it. They didn't take a loan from it. They started the study and look at how could they buy this house?

And what they did is they use the FHA. Now the FHA is a program that you can use to put a low-down payment. So in this particular case, and I actually did this when I was 22 years old, I bought my first townhouse. They put three and a half percent down, but here's the best part. They didn't even have to put that money out of pocket because they did some research and they found that the state offered some down payment assistance programs.

I did this exact same thing when I bought my first house, I was really young. So you might say, Ralph, what were the results in this case? Well, this one worked out great. They maintained that work life balance. They started a side business to make extra money because they didn't have that stress, but they wanted to bring a little extra money in. With that side business they build an emergency fund at the same time. So they had that what happens if scenario like I shared on the show a few weeks ago. I just bought my new townhouse. I was in there maybe a week and the air conditioning died and I think it was in July when I moved in. Next thing you know, I had to replace the whole AC unit.

That was $6,000 I didn't have. So this is what they did though. They started to build that emergency fund simultaneously. And the other thing they did was they protected their family's long term financial security. And that's the whole thing. So you might be asking Ralph, what are some other solutions? You got to ask yourself this difficult question about does this distribution from your retirement account really reflect your values?

And listen, I can't answer that question for you. Everybody's situation is different, but here's some alternative solutions you might want to consider. These are some creative ones and some of them are sort of off the page, but you don't fit in a box, but I’ve seen them work. First one I’m going to say is called house hacking. You know, maybe you buy that bigger house and you rent out a portion of that to somebody else to bring in extra money. Maybe you look for that starter home, you know, maybe it's not the home of your dreams. It's not that place that you want to hang your hat the rest of your life, but it's a starter home to get you into that place where you can get started.

Maybe you work with a family member and do what we call a co investment opportunity. Maybe you've got a family member who's got some money sitting out. They're not making a lot of interest on it. You talk to them and say, hey, would you be willing to help me buy this house and we'll repay you. As I talked about with the Thompson approach, and maybe you do that down payment assistance program.

I think those programs are great. I like them for several reasons. Number one, you don't have to pay the loan back until you go to sell it generally. Most times they offer counseling. So you know what you're getting into when you buy this place. Another thing you could consider doing is developed in the side business.

A lot of people do that to bring in extra money. If you find that you really can't do any of the down payment things, another thing you might want to consider, and I did a show about this a couple of weeks ago, is maybe look for one of those rent to own agreements. You find that house that somebody is willing to do a rent to own, you pay rent each month.

And as part of your rent is set aside for the potential to buy it, usually, and make sure you do that with an attorney, make sure everything's in writing, make sure everybody understands the situation. And finally, the other thing you could do is what we call explore USDA rural development loans. These are specific to particular areas, but you can look at using those as well.

So let me give you some action steps. If you're going to consider doing this, the first thing I want to tell you is go to meet with somebody professional. You can always book a call with me, but meet with somebody professional and calculate your true housing costs without your 401(k) funds. Decide what that looks like.

Another thing I want you to do is research first time home buyer programs in your area. Look at what options are out there. There are a lot of those programs that don't get taken advantage of because people just don't study them and look for them. Now the thing, another three on my list here is consider whether a less expensive starter home might be appropriate.

Listen, everybody wants that dream house with the white picket fence. But maybe you got to start off with something smaller. Maybe you do something you can put a lot of sweat equity into, maybe it's a fixer upper. Just know what you're getting into. Like me, I'm not good at that stuff. So I’m not going to go buy a fixer upper, but maybe you look at that starter home. Like I said, it's not your forever home but it gets you started.

And at the same time, number four on my list here is create a dedicated down payment savings plan. If you want to buy that house, and you know you've got to put that down payment, create a savings plan. Listen, even if you're only putting five bucks a week or 10 bucks a week, you can make it happen. You just have to be diligent about it.

You know, you create that habit. I talk about that on the show all the time. Create that habit and move forward with it. And then last but not least, number five on my list is explore ways to increase income through side work. Listen, maybe you got to work two jobs. Maybe this is a season of your life when you've got to work three jobs.

My wife talks about this all the time. When she was first getting started, she did work a lot of jobs. She worked swing shifts. She had double shifts because guess what? She had to pay her bills, so you've got to do what you got to do, and this is an opportunity to do that. So you might be asking, Ralph, what's your most memorable takeaway of this particular topic for tonight?

I'm going to tell you what it is right now. If you don't listen to anything else I say, don't sacrifice tomorrow's security for today's dream home. It's just not worth it. God's timing often protects us from our own impatience. Well, let's get to some listener questions and let me get to that next. It looks like we've got a listener question here.

Let me go here to, let's go here and drag this over there. This one comes from PokemonGuy3309. And the question is, I don't have a 401k. I have a simple IRA. What's the difference? That's a great question. So a simple IRA and a 401k are just two different types of retirement vehicles. A 401k plan is a more robust retirement plan that a business might have.

A simple IRA plan is really the business is giving you the ability to contribute money pretax into your own IRA. Now they create the infrastructure for you. In fact, that's what I offer here at my accounting practice. We have a simple IRA and generally the way they work is you will put in whatever you can, and your employer will generally match that up to 3%.

Now I'm getting right to do a show. It'll come out in the next few days. It talks about how important it is if you've got an employer that's offering one of these simple IRA plans, I'm going to tell you, it is absolutely important that you consider putting in at least enough to get to that total match.

Cause if not, you're leaving money on the table. I think in the show, I talk about, it's kind of like walking down the sidewalk, right? You're walking down, you see a hundred-dollar bill sitting on the sidewalk and you say, you know what? I'm just too lazy. I'm not going to bend over and get it. It's the same thing.

So Pokémon guy, a simple IRA you can put up to, and don't quote me on this. I think it's about $15,000. It's indexed every year with inflation. Generally, your employer is going to match up to 3 percent on that. So start off small and start building that investment. It's really going to pay off in the long run.

I just think that's a smart thing to do. Well, let's look forward to, let's see if we've got any more questions here. Salty waters, thanks for joining us and says, hello, everyone. All right. So salty waters has a question. Let me pull that in over here. And Salty waters that's a great name, by the way.

It says define what is considered a dependent for tax purposes. Okay. Well that gets a little complicated. But a dependent is basically somebody that you provide more than half of your support, half of their support in a year. And there's all kinds of rules and regulations that go around it, depending upon their age, depending upon all those types of things.

But their traditional dependent is your child, grandchild, stepchild. And like I said, there are definite different nuances to that. As your kids get older, there are then income requirements based on if they're not a full-time student. And I know I'm not giving you a great answer to that, but a dependent to somebody that generally doesn't have their own income where they have a very small amount of income, and you claim them on your tax return. What that effectively does is it gives you a tax credit for that person. So like, let's say you is you and your husband and you've got a small child at home, a newborn. So your dependent would be a newborn.

So you would get what's called a dependent credit for that. You would get what's called a child tax credit for that. All very positive things, but you got to be very careful with these because what can happen is as your children grow, for example. Let's say they're 18 years old and they're no longer in school.

Then there are other rules that come in. Maybe you have to look at how much income do they have if they have over a certain amount of income maybe they're not your dependent and here's something a lot of people don't think about. You could have dependents that are your parents. Let's say your parent or your parents didn't prepare well for retirement.

And all of a sudden, you're supporting them. You're paying more than half of their bills. I have clients in that situation where it's actually the case where you could have somebody that is an adult be your dependent. So great question Salty waters. I really appreciate you contributing to the show. And we got somebody called Donald Trump.

Well, welcome Donald Trump to the show. It's Donald Trump. That's hilarious. But well, you know what? Let's get on to our drawing and let me see if we know this is the first time I've done this. So I'm going to tell you right now, this is something new. Let me launch this over here and hit start right there and let's see what happens here.

Okay. So what it says here, if this will work, I'm hoping it's going to work. Let's see. Start. I apologize. It's acting a little funky there. All right there. Well, so here's what we're going to have to do. So if you want to enter into the drawing for tonight, what I need you to do is I need you to go into the comments and just put your email address in there.

And if you'll put your email address in there, I will just, I will pick randomly somebody, and we will give you that $100 Amazon gift card. I had a fancy thing set up here to do this gift card drawing. But for some reason, when I go to hit start, it's telling me that I don't have a live video activated on the page.

So I apologize for that. But like I said, if you will go into the comment section and just put your email address in there, or you can direct message it to me if you want to do it direct to me, then I will do that drawing for tonight. So I really appreciate that. I don't see any other questions tonight.

So don't forget, put your email address there in the comment section and we'll do a random number drawing and somebody's going to win a hundred bucks tonight. Well, let me ask you this before we end tonight. It's getting close to being Christmas time. Next week is Thanksgiving. I guess that's the sort of the unofficial start of the Christmas shopping season.

Let me ask you, are you losing sleep wondering how you're going to afford everything on your holiday list this year? Are you tired of starting every new year buried under a mountain of holiday debt? Do you want to create magical Christmas memories without the financial stress that usually comes with them?

Well, I've got the perfect thing in mind. I'm going to help you discover peace of mind with my free surviving the holidays without going broke guide. I wrote this about a month ago. It's something I've been promoting on the show, but I want you to hear about this. I want to share with you a proven budget system that actually works to help you get through the holidays without running up that credit card debt.

I'm going to talk about some smart shopping strategies to slash your cost. Hey, we all got to do that. I'm going to show you ways to create magical memories without maxing out those credit cards. I don't know how many people I meet with in January and February and they tell me Ralph, we had a great Christmas, but man I’m still paying off the credit card debt. You don't want to get yourself into that position.

I'm also going to share with you some tips for teaching kids gratitude. I say this in what I call the gimme more world. We've all got those young kids around us. Give me more, Give me more. Give me more. But are you really sharing with them the true reason for the season and the final thing I talk about in my guide Is how to keep your faith and family at the center of your celebration because it's a Christian podcast.

It's all about Jesus. It's all about the greatest gift that any of us could have ever received. So don't let those January credit card bills, steal your holiday joy, download your free guide now. You get it at askralphpodcast.com/christmas and make this your most meaningful and dare I say, affordable holiday season yet. Your stress-free holiday season starts here. Again, that's at askralphpodcast.com/christmas. Well, let me just take another quick look and I want to thank everybody for joining us tonight. Again, put your email addresses in the chat window there, or you can direct message me with those.

You can send an email to ralph@askralph.com. Once I get those in we'll send that gift card to the lucky winner. And as I close tonight, remember this. My passion is to help you achieve financial success. I truly want to see you live out your dreams, I want to see you grow in your faith, and I know together we can master your finances from a Christian perspective. So as I always end this show, I want to encourage you to stay financially savvy out there and may God bless you.

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