Can I Use My 457 to Buy a House?

A 457 plan is a type of deferred compensation retirement plan available to employees of state and local governments and certain tax-exempt organizations. This article explores the specific rules and considerations for accessing 457 plan funds for a home, along with other financial options for home buying and the broader financial effects of using retirement savings.

Overview of 457 Plans and Distribution Rules

Two types of 457(b) plans exist: governmental 457(b) plans, offered by state and local government entities, and non-governmental 457(b) plans, sponsored by tax-exempt organizations. Governmental 457(b) plans typically hold funds in a trust, providing protection from the employer’s creditors. Non-governmental 457(b) plans are generally unfunded and remain subject to the employer’s creditors in the event of financial distress.

Accessing funds from a 457 plan is restricted to qualifying events. These events include separation from service, death, or disability. An “unforeseeable emergency” is another condition for distribution, which is narrowly defined.

Distributions from 457(b) plans are taxed as ordinary income in the year they are received. Unlike many other retirement accounts, governmental 457(b) plans do not impose the 10% early withdrawal penalty for distributions taken before age 59½, provided the employee has separated from service. This flexibility in early distributions is a notable feature compared to 401(k) or IRA plans.

Accessing 457 Funds for a Home Purchase

A direct withdrawal from a 457 plan for a home purchase is not a qualifying event. Unlike some other retirement accounts with provisions for first-time homebuyer withdrawals, 457 plans do not offer this exception. The rules for accessing 457 funds are more stringent, focusing on events like separation from service or a severe, unexpected financial hardship.

An “unforeseeable emergency” allows for distributions due to severe financial hardship resulting from circumstances beyond a participant’s control. Examples include severe illness or accident, property loss due to casualty, or imminent foreclosure or eviction from a primary residence. Purchasing a home, even if urgent, does not typically meet this strict standard unless it is a replacement for a primary residence lost due to an uninsured natural disaster. The IRS states that the purchase of a home does not qualify as an unforeseeable emergency.

Some governmental 457(b) plans may permit participants to take a loan from their account. The maximum loan amount is the lesser of 50% of the vested account balance or $50,000. An exception allows borrowing up to the full vested balance if it is less than $10,000. These loans must be repaid within five years, but the repayment period can extend up to 15 or 30 years if the loan is used to purchase a primary residence, depending on the plan’s provisions. Non-governmental 457(b) plans do not allow for loans.

Separation from service is a trigger for accessing 457 funds. Once an individual separates from employment with the plan sponsor, they can receive distributions from their 457 plan. These distributions can be used for any purpose, including a home purchase, as they are no longer subject to in-service withdrawal restrictions. Any distributions received are subject to ordinary income tax, but for governmental 457(b) plans, the 10% early withdrawal penalty does not apply.

Other Financial Options for Home Buying

Traditional mortgages remain the main method for financing a home purchase, involving borrowing funds from a lender that are repaid over an extended period with interest. Beyond conventional loans, other options exist for buying a home.

Many employer-sponsored 401(k) plans offer a loan option, allowing participants to borrow up to 50% of their vested balance, capped at $50,000. If 50% of the vested balance is less than $10,000, some plans allow borrowing up to $10,000. These loans are repaid with interest, and the interest payments are credited back to the participant’s account. Repayment periods are five years, but can be extended to 15 years for a primary residence purchase.

Individual Retirement Accounts (IRAs) offer a provision for first-time homebuyers. Individuals can withdraw up to $10,000 from their IRA (traditional or Roth) without the 10% early withdrawal penalty for qualified acquisition costs of a first home. This is a lifetime limit; if married, both spouses can each withdraw up to $10,000 from their respective IRAs, totaling $20,000. While the penalty is waived, traditional IRA withdrawals are still subject to ordinary income tax. For Roth IRAs, withdrawals of contributions are tax-free and penalty-free. Earnings can also be tax-free and penalty-free if the account has been open for at least five years and the homebuyer exception applies.

Beyond retirement accounts, individuals can use personal savings, investments held in taxable brokerage accounts, or other liquid assets for a home purchase. These sources avoid the complexities and potential tax implications associated with retirement plan withdrawals.

Financial Implications of Using Retirement Savings

Using retirement savings, such as those in a 457 plan, for a home purchase carries financial implications. Withdrawing funds reduces the principal amount in the retirement account, impacting future growth through compounding. This loss of compounded earnings over many years can result in a smaller nest egg at retirement.

Distributions from 457 plans are subject to ordinary income tax. Depending on the withdrawal amount and the individual’s other income, this could push them into a higher income tax bracket for that year, increasing their overall tax liability. While governmental 457(b) plans do not impose the 10% early withdrawal penalty, state income taxes may still apply to the distribution.

The decision to use retirement funds creates an opportunity cost, meaning the lost potential earnings from investments that would have continued to grow tax-deferred. Money removed from a tax-advantaged account loses its ability to grow without annual taxation. Consulting with a qualified financial advisor can help individuals assess their circumstances and understand the long-term financial consequences of using retirement savings for a home purchase.