A house down payment can be a significant amount of funds. With our current low interest rates, it’s a big chunk of money that isn’t earning very much income. So should it be invested in stocks instead, where you have a chance of earning some money as you do so? Can you take it out of your retirement account?
Stocks are for long-term goals
No one knows what the stock market will do in the short term. (If anyone tells you they do know, run away from them as fast as you can. More details here.) So it’s possible that even if the market has been humming along the entire time you’re saving, there could be a big drop the exact day that you need to withdraw your money to make the payment.
Not only are you locking in your losses if you are forced to sell your stocks to make the payment, you might not have the amount of money you’d planned on having in the first place.
Over the long term, which I would define as ten or more years, stocks will outperform bonds and cash. If your timeline is shorter than that, it’s not a good idea to use stocks (and stock mutual funds) for this money.
Bonds are good for medium term goals
If you are planning to buy a house in five years or so, bonds or bond mutual funds are a good way to earn a bit extra on your money. With interest rates as low as they are, it is not much extra, but at least your money will be earning a little something as you set it aside.
The bond market can drop slightly — one to two percent — so you might want to park money that’s needed in the next year in a (relatively) high-yielding savings account.
Avoid using your retirement account to save money for the house (unless you’re over age 59 ½)
It’s true that you can withdraw $10,000 from your retirement account without paying a penalty if it’s for a house downpayment. Just because you can, doesn’t mean you should.
I currently live in an area with a relatively low cost of living. Still, a 20% down payment on a $200,000 house is $40,000, so the $10,000 allowable withdrawal doesn’t actually go very far.
If you withdraw from a Traditional (pre-tax) account, even if you don’t pay a penalty, you are taxed on the full amount of the withdrawal. Your $10,000 could be $8,000 or even less by the time you receive it. If you pull out a larger amount, you’ll pay a penalty for the amount greater than $10,000. Of course, that amount will be taxed too.
When withdrawing from a Roth account, the amount is not taxed since the account is funded with after-tax money, as long as you’re removing just your contributions. If you’ve had the account less than five years, penalties apply.
Retirement accounts should be held only for retirement.
Once you start withdrawing from the account before retirement age, the danger is that you’ll begin thinking of it as just another account. You’ll continue to withdraw from it, likely incurring penalties and/or taxes as you do so. Then when you reach retirement, you’ll have much less money than you planned on when you saved the funds.
So why not use a Roth? In addition to the objection above, your retirement accounts should be invested for retirement. Which, if you’re not age 59 ½ or near it, is a long-term goal and should be invested mainly (or entirely) in stocks. If you’re saving for a house down payment and investing your Roth in bonds, you’re hurting your portfolio’s chances for long-term growth. Your retirement account will be underfunded.
Make sure you’re balancing current needs with future needs
The tax benefits of buying a house will not be as attractive going forward from 2019 due to the recent tax act, but there will still be some. Buying a house is a goal many people have, and it’s a worthy one. However, you can still have a roof over your head by renting, if you can’t afford a house without pulling money out of your retirement savings.
You need to save for retirement, and there is no alternative to not having money in retirement.
You can’t eat your house.
So keep your retirement savings separate, and protect yourself by avoiding stocks while you’re putting together the down payment (unless you don’t plan to buy for another decade or so.)
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Originally published on Fab Fem Finance.