Should I be contributing more to my 401(k) account since I don't have an employer match, or should I put that money towards saving for a home?
I'm 35 years old and I'm currently contributing 10% to my 401(k) with no employer match. I contribute the maximum amount to my IRA account every year. I save $1,000 every month after taxes in an emergency fund. I don't have any debt. My goal is to save enough to purchase a home, but feel like that's a hard goal to achieve. Should I be contributing more to my 401(k) account since I don't have an employer match? Or should I put that money towards saving for a home?
Congratulations on not having any debt and building up your Emergency fund.
how about having your cake and eating it too! Meaning... You can do both by contributing to your 401k and (when you are ready) accessing that money for a home purchase!
There are a few pitfalls with this idea:
- your 401k is volatile and your savings could drop dramatically just at the time you are wanting to access it for your purchase
- You may be best to "borrow" or take a loan from your 401k up to $50,000 or half of your balance. I never encourage you to borrow from your future self, but it is an option.
- you may endure a 10% penalty if it is a non-qualified distribution (hence the loan may be best).
- The equity that you are building may not be that much.
Lets take a deep dive into each of these pitfalls:
#1, if this is a purchase that is going to be made in the next few years, you are best placing your money in a high yield online saving plan. I suggest looking at bankrate.com for programs that are paying over 2% and fully liquid. The reason to avoid putting this money in a 401k is that you want the money easily accessable at the time of your purchase. In addition, the volatile may erode your savings.
#2 If you borrow from your 401k, be mindful of the challenges and the payback process. At the end of the day, you will have to pay back this loan over the next 5/10 years and that will mean less cash flow. Here is a good link that highlights these challenges: https://www.investopedia.com/ask/answers/111815/can-401k-be-used-house-down-payment.asp
#3 The 10% penalty. Even though the distribution will be used towards the purchase of your first home, the first-time homebuyer exception does not apply to distributions from qualified plans like your 401(k)... It applies to IRAs. If you qualify as a first-time home buyer, you can withdraw up to $10,000 from your IRA to use as a down payment (or to help build a home) without having to pay the 10% early withdrawal penalty. However, Uncle Sam wants your money and you'll still have to pay regular income tax on the withdrawal.
#4 Equity. There are several good reasons to buy. The one that tops my list is Pride Of Ownership. Many are convinced that it is a fantastic wealth building tool. Unfortunately, that is not always true. You might find it beneficial to read this blog post from Eric Roberge, CFP® and fee only advisor. Here is an in-depth review of building house equity and how it companies to renting in the big city: https://beyondyourhammock.com/building-house-equity/.
I hope this helps and points you in the right direction.
With love and regards,
Jose Sanchez, CFP®
This is a great question many people encounter who are looking to buy their first home. I always argue that the home buying decision is a lifestyle choice that shouldn't necessarily be boiled down to weighing it against other financial decisions. As long as you're able to afford a downpayment and the monthly costs associated with home ownership there shouldn't be an issue with buying a home. Again, that comes back to how high of a priority it is of yours to own a home, have a stable place to potentially raise a family or the other lifestyle benefits that come with home ownership.
If you're purely looking at it from an investment perspective, maxing out your 401(k) would likely be the better choice, given that you've properly allocated the investments within it correctly to account for the 25+ year until you'll withdrawal those funds.
If your goal is to purchase a home starting to set aside more cash in a high-yield savings account can be a good strategy, therefore you're not exposing the home down payment capital to market fluctuations as you work towards building enough cash for a downpayment.
Great question and capital allocation is really where advisor advice shines!
The general rule when saving for retirement is to save 10-15% of your income to retire at a normal age. Based on the information you've provided, you're meeting and exceeding this goal.
For your emergency fund, it's advised that you save about 3-6 months worth of expenses. Three months if your job is stable and on up to six months worth of expenses if not(or if you just feel safer with that amount.)
If you have a fully or mostly funded emergency account, which you probably do, you can definitely feel safe stop contributing so much to your retirement accounts and start saving for your house! If the house is more than three years away, you can feel safe opening a brokerage account and saving/investing towards your house.
Hope this helps!
The biggest mistake I see investors make is saving too much in retirement accounts for the tax deduction. Then don't have enough on the outside for alternative investments or a downpayment on a home. You could do a Roth IRA where you can take out any or all contributions for any reason at any time penalty & tax free because you already paid the tax on the contributions. This way it could be a hybrid savings/investing account while a retirement account as well.
Normally, a good rule of thumb is to save 30% to 40% on the outside & 60% to 70% in retirement accounts. This leave you flexible enough to handle "life" as well as retirement. These are just my thoughts without knowing enough of your details like how much you already have saved outside your retirement accounts versus how much you have inside your retirement accounts.
Hope this helps and best of luck, Dan Stewart CFA®
First of all, congrats on being in a stellar financial position. You are doing all the right things by saving into your 401(k), maxing out your IRA, and keeping an emergency fund. 401(k)'s do not have distribution exemptions for a home purchase so if you were to take the funds out of your 401(k) for a down payment, you would have to pay the 10% penalty plus ordinary income tax, so this is not a good option for you. You could take the money out as a loan up to $50k or half the value of the account, whichever is less. The downsides to this are you'd have to pay it back with interest and you'd be forced to make monthly payments back to your 401(k) in the form of payroll deductions. As long as you plan to stay at your current employer long enough and can handle the payments, this can be a solid option for you. If your IRA is a Roth and you've held the account for at least 5 years, you can take out any contributions you made to it tax and penalty-free. You can also take out up to $10k in earnings without penalty or tax as long as it is used for the purchase, repair, or remodel of your first home. If your IRA is a traditional IRA, then you can only withdraw up to $10k for a home purchase without paying any penalty, but you must pay ordinary income tax on the entire amount AND purchase the home within 120 days or you'll be fined the 10% penalty. If none of these options make sense for you, then you may want to consider lowering your contributions to your 401(k), especially considering you don't have an employer match, and instead fund a standard brokerage account with a portfolio suitable to your risk tolerance and the time horizon (how long until it's needed for down payment) for the funds, or simply put it into your savings account. American Express has a high yield, FDIC-insured savings account right now that pays around 1.45% right now (see here), so that could be a good option if you want to go the cash savings route. One thing to note about reducing your 401(k) contributions, be careful about how much you chose to reduce as this could potentially bump you into a higher tax bracket and effectively defeat the entire purpose of the reduced contributions in the first place.