Dave Ramsey: Don’t Use Your 401(k) to Pay Off Your House

A lot of people don’t save a dime for retirement and wind up having to live on Social Security alone once they stop working. So if you’re someone with money in a 401(k), you’re ahead of the game to a large degree.

But that doesn’t mean you don’t need to be careful with your 401(k). And you should definitely be cautious about using your 401(k) for anything other than your retirement, says Dave Ramsey.

A while back, a caller asked Ramsey if she should cash out her 401(k) to pay off some credit card debt as well as put down money on a home. She explained that her rent is going up, and she’d rather get into a home in a better school district.

Ramsey had some key advice for her. And it’s applicable to anyone in a similar situation.

The danger of taking money out of your 401(k)

It’s easy to see why the caller here would be interested in cashing out her 401(k). It’s really the only way she’d be able to purchase a home.

But as Ramsey explained, any money that’s pulled out of a 401(k) is going to be taxed. Plus, there’s a 10% early withdrawal penalty for tapping a 401(k) before age 59 and 1/2.

Ramsey told this caller that between the penalty and her tax bracket, she’ll basically lose 40% of any amount she withdraws from her 401(k) off the bat. So as he says, “that would be stupid.”

Ramsey also said that because the caller is in debt already, she shouldn’t be using her 401(k) to buy a home. She should stay put in her rental, or try to find a cheaper one, and then work on digging out of debt while keeping her retirement savings intact.

“You don’t need to be cleaning out your 401(k) and adding to the stupid sauce,” he said. And he’s not the only one who has pointed out the pitfalls here. Karla Dennis, a finance industry expert goes further, pointing out that state takes are a factor as well:

“Typically, withdrawing from your 401(k) before age 59½ incurs a 10% early federal withdrawal penalty, a state early withdrawal penalty, which may vary by state, along with income taxes”

There is a consensus among the experts here, DO NOT tap your 401(k) earlier than needed. To really hammer the point home, use the withdrawal calculator below to see how much your retirement could be worth if left alone. The figures are truly staggering:

Why tapping a 401(k) ahead of retirement is a bad idea

The reality is that the caller above needs to clean up her financial act, according to Ramsey. But even if she was in a better or different financial situation, it would still be a bad idea to raid her 401(k) to buy a home.

Aside from facing a penalty, the problem with tapping a 401(k) ahead of retirement is that every dollar you remove is a dollar less you’ll have for your senior years. But that’s when you’re likely to need the money the most, since you won’t be working.

Remember, too, that when you take an early 401(k) withdrawal, you don’t just lose out on that exact amount of money down the line. You also lose out on investment gains. So all told, you could be looking at a lot less money in your 401(k) if you take a withdrawal during your working years, whether it’s to buy a home, pay off debt, or do anything else ahead of retirement.

If you’re thinking of tapping your 401(k) early, before you do, talk to a financial advisor. They can explain what consequences might ensue if you do that. And they may also be able to offer other solutions for meeting near-term goals or addressing financial concerns without putting your retirement savings at risk.