Some millennials, Gen Zers plan to use retirement savings to buy a home. They ‘really shouldn’t’, says the adviser

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Some young retirement savers say they can raid their 401(k) accounts to buy a home. However, this could be to their detriment, experts warn.

Nearly a third (30%) of aspiring homeowners say they plan to withdraw funds from their 401(k) plan to finance a purchase, according to the Real Financial Progress Index from BMO Financial Group. BMO surveyed 2,505 US adults this spring.

Millennials and Generation Z are more likely than older generations to say they will cash out of their 401(k), BMO found, at 31% and 34%, respectively. By comparison, only 25% of Gen X homebuyers and 16% of baby boomers plan to draw on retirement funds for a home purchase.

“You really, really, really, really don’t have to retire on a house,” said Stacy Francis, a certified financial planner and president and CEO of Francis Financial in New York City.

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In general, early withdrawals from retirement accounts may incur taxes and a 10% penalty unless the account owner meets a listed exemption. For both IRAs and 401(k)s, qualifying first-time buyers may be able to withdraw up to $10,000 penalty-free. With a Roth IRA, owners can withdraw their after-tax contributions at any time without penalty.

Still, “it’s much better to put those dollars to work for you,” said Francis, a member of CNBC’s Financial Council.

While a 401(k) loan may be a better option to meet the down payment needed for a home purchase, doing so involves its own set of financial risks, experts say.

‘Significant financial consequences’ for withdrawals

More savers tapped into their retirement savings last year, which experts say shows some families were struggling financially. In 2023, 3.6% of savers took hard withdrawals, up from 2.8% in 2022, according to Vanguard’s How America Saves 2024 preview.

But taking withdrawals from your 401(k) plan can have “significant financial consequences,” said Tom Parrish, head of lending at BMO. Not only will you damage your designated retirement funds, early withdrawals can also often subject you to the associated penalty fees and taxes, he said.

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“There’s a reason there are limits on these accounts. They’re in your favor,” said Clifford Cornell, a certified financial planner and an associate financial advisor at Bone Fide Wealth in New York.

For example, a 30-year-old worker who left $10,000 in their 401(k) instead of withdrawing it could end up with nearly $77,000 more for retirement at age 65, assuming average returns annual of 6%.

The pros and cons of 401(k) loans.

While experts say taking out a loan against your 401(k) is generally a bad idea, it can be a nicer option for a down payment or part of the closing costs of a home, versus a withdrawal.

Federal law allows workers to borrow up to 50% of their 401(k) account balance or $50,000, whichever is less, without penalty as long as the loan is repaid within five years.

“The key thing is to make sure you pay it off over that period of time,” Parrish said.

However, if you leave your company — whether you’re fired or find a new job — most employers will require your outstanding balance to be paid off sooner.

Another danger is that you overestimate your household budget. Buying a house involves long-term and real commitments, Francis said. Buyers are not only responsible for the down payment, moving and closing costs, but also have to consider ongoing mortgage payments, real estate taxes and maintenance costs.

“It will be a very expensive thing for you to do,” she said. If “one little domino falls the wrong way,” you may not be able to pay either the 401(k) loan or the mortgage, putting yourself in a “real deep financial hole,” Francis said.

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