Retirement aside, owning a home is the most significant financial milestone of our lives.
Yet many Millennials, who are struggling to reach the same financial milestones as their parents, have found home ownership particularly elusive.
According to a report from the National Association of Realtors, the number of Millennials living with their parents increased almost 15% from 2006 to 2013. Meanwhile, the percentage of first-time homeowners has fallen to 32%, the lowest level since 1987.
Still, home ownership remains a central component of the American Dream and an important step toward financial security. Thus, many Millennials are finding creative ways to afford a house of their own – including using 401(k) funds to make the initial down payment.
Now, if you can afford to do such a thing at all, you’re breathing rarefied air. About a year ago, Forbes reported that 68% of working-age people (25 to 64) didn’t even participate in an employer-sponsored retirement savings plan.
Even those who did weren’t swimming in money. A December 2014 report from the Employee Benefit Research Institute – a non-partisan, non-profit research institute that studies employee benefit programs and social policy – estimated that the median amount in a 401(k) savings account was $18,433.
Still, that’s a solid chunk of change, and if it’s the difference between renting for several more years and beginning to build equity in a home, it’s easy to see how the move would be tempting.
Broadly speaking, there are two methods for buying a house with 401(k) money – rolling the funds into an IRA and withdrawing them, or taking out a loan against the 401(k).
You can’t roll over funds from a 401(k) that’s with an employer for whom you still work, but you can roll over an old 401(k) into a new IRA. With a Roth, you’ll pay taxes on the rollover amount, but are then free to withdraw the funds without paying a penalty. If you’re a first-time home buyer, you also have the option to roll your old 401(k) into a traditional IRA and withdraw up to $10,000 for the purchase of your home, penalty-free.
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The other option is to take out a loan on your 401(k), which can be worth as much as $50,000 or half the value of the account – whichever is less. While you’ll have to pay interest on the loan, you’ll avoid paying taxes on the funds as well as the withdrawal penalty.
However, just because we can do something doesn’t always mean that we should…
Building Wealth With Patience
Deciding whether it’s worth using 401(k) funds to buy a house is a complicated endeavor. There are many, many facets to consider, but in an attempt to decide broadly whether it’s worth it, I’ve narrowed my focus to one.
That is, the return that an individual can expect on a hypothetical 401(k) versus a home.
The historical return of a 60/40 stocks and bonds portfolio, net of inflation, is about 5%. That’s a relatively conservative portfolio, particularly for a Millennial who could have upwards of 30 years left before they begin withdrawing from their 401(k).
In fact, it’s very likely that our hypothetical investor would have a more aggressive allocation. Perhaps a better baseline is the S&P 500, which has posted an average annual return of 7%, net of inflation.
By contrast, the median annual change in the real house price index – an inflation-adjusted indicator of house price trends – is a measly 0.34%.
Thus, while a 401(k) won’t put a roof over your head, it’s virtually guaranteed to be a better tool for building wealth than buying a home.
Yes, it may be frustrating to throw money away on rent for a few more years while saving for a down payment the old-fashioned way, but we’re still young, and, as the Rolling Stones once sang, time is on our side.
To Living a Richer Life,