The day we’ve all been waiting for has finally arrived: Millennials are starting to buy homes.
But a new study from Down Payment Resource says that almost 30 percent of them are dipping into their retirement savings for the down payment. Is this truly the best way for new homeowners to fund a real estate purchase?
Millennials from ages 21 to 34 who own a home were more likely to use retirement funds for their down payments than any other source of funding. At the same time, more than a third of Millennials want to buy their first home in the next year, the study reported.
But there are serious tax ramifications that may stand in the way of the measly 33 percent of Millennials that are actively saving for their retirement, a National Institute on Retirement Survey noted.
“Most people are very surprised when they see how much it ‘costs’ tax-wise to take an early retirement plan distribution before they reach the magic age of 59 and a half,” Kathy Vaccaro, owner of Burlington-based Goldberg & Vaccaro Tax Services LLC, told Banker & Tradesman
While there are exceptions, funds removed from a 401(k) before that ripe age typically incur regular income tax plus a hefty 10 percent penalty for making an early withdrawal.
For example, if a typical married couple in Massachusetts earning a combined $120,000 withdrew $10,000 from a 401(k), regular income tax would come to $2,700 and the 10 percent penalty would then be added for an additional $1,000. A $10,000 withdrawal becomes $6,300 after taxes, effectively a 37 percent tax rate, Vaccaro said.
While a 401(k) is the most popular method for retirement saving, it isn’t the only one. A Roth IRA has better options for withdrawals under $10,000 than a 401(k), Vaccaro said, as it avoids the extra 10 percent penalty. But another consequence is that large, one-time withdrawals from either account causes some unrelated tax deductions and credits to disappear when income hits certain limits. This could add thousands to the real tax “cost,” Vaccaro warned. Alternatively, if they’re feeling good about their ability repay, prospective homeowners could take out a loan against their 401(k) with no tax hit. There’s also the time-tested option of a so-called “parent loan,” a gift from a relative that carries no tax consequences.
But the reality for most first-time homebuyers is that family funds or a 401(k) loan are not available. In that case, Vaccaro said, borrows may have to bite the bullet and take the tax hit in order to own a home.
“It’s not necessarily a bad decision, as long as they fully understand the tax ramifications before they crack open their retirement account piggy bank,” she said.
Whether Millennials raid their retirement fund or take out a loan, in the Massachusetts market, they’ll still be contending with a competitive, inventory-starving market and rising sales prices.