Borrowing from Retirement Accounts – (Q & A)

Feb 2017


Dear Rick:
I have a little dilemma I hope you can help me with. I have been divorced for about five years. At the time of the divorce my ex-wife and I sold our house and split the proceeds. Since that time, I have been renting. A couple years ago, I moved out of my apartment into a house. The owner of the home has offered to sell me the house on land contract. He owns the house free and clear. The one issue I have is coming up with the down payment. I need to come up with $15,000 to buy the house. I should note that my land contract payment will be less that what I was paying for rent. My question is the $15,000. I have a few different options and I hope you can help me decide which one makes more sense. The first option is to borrow the money. I sat down with a lender for a personal loan and I was approved for $10,000. Of course, the interest is very high – 14 percent. Another option is to take a loan from my 401(k) Plan. I can virtually borrow all the money from my 401(k) Plan. The interest is about five percent. My last option is to take a withdrawal from my IRA. Since I’m under 59½ I was told in addition to taxes I would also have a penalty. Hopefully, you can give me some direction as to which way to go.


Dear Paul:
In reviewing your options, I like a combination of withdrawing from your IRA and taking a loan from your 401(k) Plan. I am not a fan of borrowing the money at 14 percent interest. That is excessive considering where interest rates are today.

My advice would be to first take a $10,000 distribution from your IRA. Because under tax laws you would be considered a first-time home buyer, you can withdraw up to $10,000 and not be subject to the penalty even though you are under 59½. Yes, you have to pay the tax on the money, but there is no penalty.

Many people are under the mistaken belief that if you’ve owned a house in the past you would not qualify for some of the breaks given to first-time homeowners. That is not the case. Under tax law, the issue is whether or not you owned a house in the last two years. Since you did not own a house in the last two years, you qualify for a penalty-free IRA withdrawal. The maximum you can withdraw for first-time homeowner is $10,000.
To make up the difference I would take a loan from your 401(k) Plan. Generally, I’m not a fan of borrowing from 401(k) Plans, as I believe the money is for retirement and retirement is sacred. However, there are certain situations where borrowing from a 401(k) Plan makes sense. I believe this situation is one of those times.

In borrowing from a 401(k) Plan one thing you need to be aware of is that with many companies, if you have a loan outstanding on your 401(k), you cannot add new contributions. If that is the case, then you need to make sure you pay that loan off as soon as possible. Particularly, if your company matches, you want to make sure that you don’t lose that opportunity.

When someone wants to take a loan from their 401(k) Plan to take a vacation or to buy a new car my general answer is no. The purpose of retirement money is to use when you’re retired, not sooner. If you get in the habit of withdrawing from your retirement accounts before retirement, I can almost assure you that you will have limited resources in retirement and that is not what you would want. Therefore, don’t look at your retirement accounts as a savings account that you can tap into on an as-needed basis; rather, look at it as money that you will only use when you are retired.

Good luck!