Can You Use the CARES Act 401(k) for a House Down Payment?
Explore how the CARES Act 401(k) provisions can assist with a house down payment, including tax implications and long-term financial effects.
The CARES Act, enacted in response to the COVID-19 pandemic, introduced several financial relief measures, including provisions related to 401(k) plans. A key question has been whether these funds can be used for a house down payment, prompting discussions about leveraging retirement savings during times of need.
Qualifications for Accessing Funds
Under the CARES Act, individuals could withdraw up to $100,000 from their 401(k) accounts without the usual 10% early withdrawal penalty, provided they met specific criteria, including financial hardship due to the pandemic. However, this provision applied only in 2020. As of 2024, standard withdrawal rules are back in effect, meaning accessing funds for a house down payment now involves evaluating current tax implications and penalties.
Tax and Penalty Considerations
The IRS imposes a 10% penalty on early 401(k) withdrawals for those under 59½, with limited exceptions. While the CARES Act waived this penalty in 2020, it has since returned. Withdrawn amounts are also subject to ordinary income tax, which can increase taxable income and potentially push individuals into higher tax brackets. For instance, a $50,000 withdrawal for someone in the 24% tax bracket could result in $12,000 in federal taxes, plus any applicable state taxes. Alternatives like 401(k) loans may be more tax-efficient, as loans are not taxed as income. However, failure to repay a loan converts it into a taxable distribution.
Repayment Options
401(k) loans allow individuals to borrow from their retirement savings and repay the amount over time, typically within five years, avoiding immediate tax liabilities and penalties if repayment terms are met. Loan interest, usually the prime rate plus 1%, is repaid into the borrower’s account. However, if the borrower leaves their job, the outstanding balance may become due immediately. Failure to repay results in the loan being treated as a taxable distribution. Exploring other financial resources, such as personal or home equity loans, may provide additional repayment flexibility.
401(k) Loans vs Withdrawals
The choice between a 401(k) loan and a withdrawal depends on immediate financial needs and long-term retirement goals. Loans provide access to funds without triggering taxes or penalties but require adherence to a repayment schedule. Withdrawals, on the other hand, offer unrestricted access to funds but result in immediate tax consequences and a permanent reduction in retirement savings. While certain exceptions to penalties exist, they are limited and require specific qualifications.
Potential Impact on Account Growth
Accessing 401(k) funds, whether through a loan or withdrawal, reduces the account’s compounding growth potential. Retirement accounts rely on long-term investment returns to build wealth. For example, a $100,000 balance earning an average annual return of 7% could grow to nearly $387,000 over 20 years. If $50,000 is withdrawn or borrowed and not replaced, the ending balance could drop to approximately $193,000. Timing also matters—accessing funds during a market downturn can lock in losses, further affecting growth.