Your 401(k): Should You Make a Withdrawal to Buy a Home?

Last Updated May 10, 2010 7:35 PM EDT

Dear Ali:
I am 60 and would like to buy a $100,000 condo, which I plan to sell in 10 years when I retire. I am going to pay all cash. I have $40,000 in my bank account, so I would withdraw $60,000 from my 401(k) for the balance.

My question for you: is this a good investment? The condo would save me $1,000 a month on rent.
A: Don't do this!

You don't mention why you want to buy without a mortgage. Maybe it's to avoid taking on more debt. Maybe you're buying a foreclosure and you can get a faster and better deal as a cash buyer.

However, I would never advise you to crack into your 401(k) nest egg to do so.

The reason is simple: by putting money into your 401(k), you've put it in a place where it can grow tax-deferred. If you take the money out and put it into real estate, you're going to have 20 percent of your withdrawal held as a reserve against future taxes.

It's probably a better investment to buy a home with a mortgage (even if it's a slightly more expensive condo) because then you can deduct the interest.

Here's a hypothetical example: If you buy a $100,000 condo for cash, sell it for $150,000 in 10 years, and your monthly costs aren't deductible, you'll make $50,000. You paid $12,000 to get your money out of your 401(k), so that's really $38,000 over 10 years, or $3,800 a year. Plus you're saving $12,000 a year on rent, so you're "making" $15,800 a year on your $100,000 investment, or 15.8%.

However, if you bought a $140,000 condo with a $100,000 mortgage and it rose in value by $50,000 over 10 years, you make more money. Why? Because at the end of the 10 years, when you sell the place for $190,000, you only have an $81,000 mortgage, so you get back $108,000. That's a jump, from the $40,000 you put in, of $68,000 in ten years. Call that $6,800 per year.

Plus, you've saved $12,000 a year on rent. Now I know you've been making mortgage payments of about $6,300 a year, but since your interest has been tax-deductible, call it more like $5,000 a year. So you're saving $7,000 a year here.

So you're "making" $13,800 a year on your $40,000 investment, for a not-too-shabby return of 34.5%

What's more, your 401(k) money is still working for you. It might return 3% a year if you put it in long-term CDs and more if you take a little more risk and put in a mix of CDs and high-yielding blue-chip stocks. (I would keep some of it in cash if you're only 10 years away from retirement; we've seen how volatile the economy can be.)

Good luck!

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  • Alison Rogers

    Since graduating from Harvard summa cum laude, Alison Rogers has been a reporter, an editor, a real-estate agent, a Wall Street desk jockey, a columnist, a failed flipper, and a landlady. A member of the National Association of Realtors, she currently sells and rents luxury co-ops in Manhattan for the Chelsea-based firm DG Neary. (If you've got $27,500 a month, the firm has an apartment for you!) Her book, Diary of a Real Estate Rookie, was called "a valuable guide for rookie buyers" by AOL/Walletpop, "beach-read fun" by the New York Observer, and "witty" by Newsweek.