Tapping a 401(k) for a Down Payment

Can I use the savings in my 401(k) at age 59½ as a down payment on a home? If so, what are the taxes or penalties? Is there any advantage if I stop contributing to my 401(k) and put money in CDs to raise more for a down payment?

In most cases, you’d have to quit your job to take a distribution from your 401(k), although some companies allow workers to take “in service” distributions once they reach age 59½. If you are permitted to take an in-service distribution, you’ll owe federal and state income taxes on the entire amount.

If that isn’t an option, you can borrow up to half of the balance of your 401(k), but not more than $50,000, regardless of your age. If you leave your job before the 401(k) loan is repaid, however, it is treated as a distribution and subject to state and federal income taxes, plus an early-withdrawal penalty of 10% if you’re younger than 55. Mortgage lenders would likely be okay with a 401(k) loan as a down payment as long as the monthly payments don’t exceed required debt-to-income ratios.

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If you cut back on your 401(k) contributions to build up cash for a down payment, make sure you contribute at least enough to capture any employer match. Otherwise, you’re walking away from free money. Directing the rest of your savings to a bank account or CD is a safe alternative for short-term goals, such as buying a house, but with interest rates at near-record lows, don’t expect to earn much. Also, keep in mind that reducing your 401(k) contributions will increase your taxable income and may make you ineligible for certain tax breaks that are tied to income.

For more information about 401(k) loans -- and alternative sources of cash -- see What You Need to Know about 401(k) Loans. Also see How to Tap an IRA for a Home Purchase for the rules on IRA withdrawals for a down payment, which are different from 401(k)-withdrawal rules.

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.