Use Your 401(k) to Purchase a House

A 401(k) plan is a defined-contribution retirement account offered by many companies to their employees. Typically, employees can make contributions to their 401(k) via direct-debit from their paycheck, and many employers offer a match up to a certain percentage of the employee's contributions.

The investment earnings grow tax-free, but distributions are taxed as ordinary income when the funds are withdrawn in retirement.

There are certain requirements that need to be met in order to take distributions from a 401(k). Failure to follow the plan's guidelines and the rules outlined by the Internal Revenue Service (IRS) can result in a significant cost to the participant or employee.

Key Takeaways

  • Usually, the purchase of your first home doesn't qualify as an exception for early distribution or withdrawal from a 401(k) plan.
  • The passage of the CARES Act allows qualified individuals eligible for coronavirus-related distributions to borrow $100,000 or 100% of the 401(k)'s vested balance.
  • The CARES Act also waives the early withdrawal penalty even if you're under the age of 59½ for distributions up to $100,000.
  • Distributions must be due to financial hardship as a result of COVID-19.

Taxes and Penalties for Withdrawals

Amounts withdrawn from your 401(k) plan and used toward the purchase of your home will be subject to income tax and a 10% early-distribution penalty (if you're under the age of 59½).

Even though the distribution will be used towards the purchase of your first home, typically, the first-time homebuyer exception does not apply to distributions from qualified plans such as a 401(k). Furthermore, if the amount you receive is rollover eligible, your employer is required by law to withhold 20% of it for federal income tax.

Direct Rollover to an IRA

Assuming you are eligible to receive the distribution and the amount is rollover-eligible, you may instruct the 401(k) plan to process your distribution as a direct rollover to an IRA. This will ensure that the 20% federal tax withholding is not applied to the amount.

Additionally, you can then withdraw the amount from your IRA for use toward the purchase of your first home, thereby avoiding the 10% early-distribution penalty. Remember, the maximum amount that may be distributed from the IRA on a penalty-free basis for the purpose of buying a first home is $10,000. This is a lifetime limit.

Eligible for an Exception?

If you are under age 59½ when the distribution occurs, your IRA custodian may report the distribution as being eligible for an exception to the 10% penalty. This is indicated with a code "2" in box 7 of Form 1099-R.

If the custodian does not make this indication, you may file IRS Form 5329 to claim the exception.

The CARES Act allows qualified individuals to borrow up to $100,000 or 100% of the vested balance in the 401(k) account as long as they are eligible for coronavirus-related distributions.

401(k) Loan

Typical IRAs and IRA-based plans, such as a SEP and SIMPLE, do not offer loans. If a loan is taken from an IRA, it's considered by the IRS to be a prohibited transaction, which means the account stops being an IRA as of the first day of that year.

In other words, the entire account would be converted to a taxable account distributing all of its assets. The funds will be charged with the early withdrawal penalty of 10% and be taxed as ordinary income if the participant is under the age of 59½.

However, individuals can borrow from a 401(k), but there are rules and limitations surrounding the loan amount and the term of the loan.

Maximum Loan Amount

The maximum loan amount that an individual can borrow is typically 50% of the vested account balance or a $50,000 maximum. A vested balance means it's the amount the participant owns of the money in the 401(k). Contributions by the employee are always 100% vested, but contributions by the employer might take a few years of service by the employee to become vested, depending on the details in the retirement plan document.

An exception to the limit is if 50% of the vested balance is less than $10,000, meaning the participant can borrow up to $10,000.


Typically, the loan must be repaid within five years by making quarterly payments. However, the IRS allows the term to be longer if you're buying a home that's to be used as your primary residence.

Retirement Loan and Distributions via the CARES Act

On March 27, 2020, President Trump signed the CARES (Coronavirus Aid, Relief, and Economic Security) Act into law. The stimulus bill was designed to mitigate economic hardship as a result of those impacted by the global coronavirus pandemic.

Retirement Loan

As part of the legislation, the CARES Act allows qualified individuals eligible for coronavirus-related distributions (CRDs) to borrow up to $100,000 or 100% of the vested balance in the 401(k) account.

However, the loan had to have been made within 180 days of the CARES Act enactment. The participant won't endure any penalties and won't owe income tax on the borrowed amount as long as it's paid back within five years.

If the loan amount is not repaid within five years, the unpaid balance is taxed as a distribution.

Early Distribution of Funds

The CARES Act also waives the 10% early withdrawal tax penalty from 401(k) plans and traditional IRAs even if you're under the age of 59½. Also, participants are exempt from the 20% mandatory withholding that is typically applied to retirement plan distributions as long as the distribution is due to financial hardship from COVID-19.

The distributions must have been made between January 1, 2020, and December 31, 2020. However, income taxes on the distribution amount still apply but can be spread out over a three-year period.

Before taking out a loan or distribution from your retirement account, please consult with a financial planner who can help decide if it's the best option for you or whether you'd be better off getting a traditional loan or mortgage from a financial institution.

Article Sources
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  2. Internal Revenue Service. "401(k) Plan Qualification Requirements."

  3. Internal Revenue Service. "Retirement Topics—Exceptions to Tax on Early Distributions."

  4. Internal Revenue Service. "Retirement Topics—Exceptions to Tax on Early Distributions."

  5. Internal Revenue Service. "Topic No. 413 Rollovers from Retirement Plans."

  6. Internal Revenue Service. "Instructions for Forms 1099-R and 5498," Page 9.

  7. Internal Revenue Service. "Instructions for Form 5329 (2019)."

  8. Internal Revenue Service. "Retirement Topics—Plan Loans."

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  10. U.S. Department of the Treasury. "The CARES Act Works for All Americans."

  11. Securities and Exchange Commission. "COVID-19 Related Early Withdrawals from Retirement Accounts—Be Careful of Fraudsters and other Bad Actors Targeting Your Retirement Savings."

  12. U.S. Congress. "S.3548 - CARES Act."

  13. Internal Revenue Service. "Coronavirus-Related Relief for Retirement Plans and IRAs Questions and Answers."

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