Can You Use Retirement Funds to Buy a Second Home?

Can you use retirement funds to buy a second home? Technically, yes, because you fund a retirement account with your own money. But perhaps a better question is: Can you withdraw funds from your retirement accounts early without incurring penalties? In this case, the answer is generally no, not before age 59 ½. Additionally, rules and restrictions may apply. Here’s what you need to know.

A financial advisor can help you create a financial plan to prepare for retirement. 

Withdrawing From a Retirement Fund

Generally, it isn’t easy to withdraw money from a retirement fund to buy a second home without incurring a 10% early withdrawal penalty.

The rules for withdrawals depend on the type of retirement account you have.

IRAs

If you withdraw money early from a traditional or Roth IRA for a down payment on a second house, you will incur a 10% penalty. ¹

Still, it’s worth mentioning that you can withdraw up to $10,000 without a tax penalty if you use it to purchase, build or rebuild your first home. However, keep in mind that you may have to pay income taxes on that $10,000.

Self-Directed IRAs

Self-directed IRAs are the one exception to the early withdrawal penalty. If you have a self-directed IRA, you can purchase a second home with the funds without incurring a penalty.

However, this is a complicated financial transaction. Your self-directed IRA will actually own the house, not you, and you cannot live in the second home. It must exist purely as an investment property.

It should also be noted that you may use these funds to buy property, but not to build property. This is an investment that only sophisticated investors should try.

401(k)s

Like IRAs, you can’t withdraw money from a 401(k) for a second home before age 59 ½ without a 10% tax penalty. ²

However, you can take out a 401(k) loan and use the funds to build or buy a second home. ³ There is no tax penalty, and you also will not have to pay taxes on what you withdraw.

Keep in mind that you will have to pay the loan back with interest, but this isn’t really a negative since you’re paying yourself back. In the end, you ensure your retirement funds will be there when you need them.

Retirement Fund Alternatives for a Second Home

Rather than raiding your retirement funds, these strategies may help you buy a second home.

• HELOC. If you have equity in your existing home, you could use a home equity line of credit (HELOC) or a home equity loan. However, this is not always ideal, as high interest rates can make borrowing very expensive.
• Cash out refinance. Similar to a home equity loan or HELOC, a cash-out refinance lets you refinance your first home to access equity. You can then use this toward a down payment on a second home.
• Fractional or shared ownership. This strategy allows you to buy part of a property, like a timeshare. While there are disadvantages to consider, this can come in handy for a vacation home you don’t plan to live in year-round.

Tax Implications of Using Retirement Funds

The 10% early withdrawal penalty is only part of the involved costs. What many miss is the impact these withdrawals have on your annual tax return.

Whatever funds you withdraw are added to your ordinary income for the year. This means you pay the IRS twice - once for the early withdrawal penalty and again for income tax.

For example, say you make an early withdrawal of $100,000 from your traditional IRA or 401(k). The 10% penalty alone costs $10,000, but the total $100,000 sum is also taxed as ordinary income.

For someone already earning $80,000 a year, this withdrawal could push a significant portion of the total into the 22% or 24% federal tax bracket. This adds another $22,000 to $24,000 in federal income tax on top of the penalty.

Combined with state income taxes in most states, the actual cost of accessing $100,000 could easily reach $35,000 to $40,000. This means you net somewhere between $60,000 and $65,000 from a $100,000 withdrawal.

Roth IRAs

Roth IRA withdrawals follow different rules. You can withdraw contributions at any time without penalty or tax, since the money was already taxed when it was contributed.

Earnings, however, are subject to both income tax and the 10% penalty if you withdraw before age 59 1/2 and before the account has been open for at least five years.

401(k) Loans

A 401(k) loan sidesteps these tax consequences as long as you repay the loan on schedule.

Loans typically have caps of $50,000 or 50% of your vested balance, whichever is less. ⁴ If you leave your job before repaying the loan, the outstanding balance generally becomes due quickly. Any amount you fail to repay is treated as a distribution, triggering both the penalty and income tax. ⁵

How Buying a Second Home Affects Your Retirement Plan

Tax Implications

The tax bill is immediate and visible. However, the long-term cost to your retirement is less obvious but often larger.

Money you withdraw early from a retirement account does not just disappear from your balance. It also loses all the compounding growth it would generate between now and retirement.

A $100,000 withdrawal at age 50 does not cost $100,000 in retirement terms. Assuming a 7% average annual return, that same $100,000 left in the account would grow to roughly $196,715 by age 60 and $386,968 by age 70. That is the real price of the withdrawal, and it does not show up on any tax form.

Ongoing Costs

There are also ongoing costs to factor in.

A second home brings property taxes, insurance, maintenance and a potential mortgage. All of these compete with retirement contributions going forward. Remember: if your purchase interferes with your ability to make retirement contributions, the long-term gap will only widen.

This doesn’t mean using retirement funds to buy a second home is always the wrong decision. Rental income from the property, appreciation over time and the personal value of having a vacation or investment property can all offset the costs.

Take the time to run the full comparison of what you lose in retirement savings versus what you realistically expect to gain from the property. A financial advisor can help you model both sides of that equation before you commit.

Bottom Line

Before using retirement funds to buy a second home, you should first note any restrictions and consequences for your retirement savings. It may be worthwhile to calculate how much money you will lose over time by taking an early withdrawal and compare other alternatives for your financial plan.

Tips for Investing in Retirement

• A financial advisor can adjust your retirement plan for your investment needs and goals. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you want to know how much an investment can pay, SmartAsset’s free investment calculator can help you get an estimate.

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