Help Me Retire: I ruined my family’s finances by withdrawing from my 401(k) to buy a house — and I regret it

I have been saving up money with my family in order to buy our first home. Recently, however, interest rates have risen, making me worry that this window to get an affordable house was closing. In a fit of panic, I withdrew all of our $26,000 saved money from my 401(k), putting it in a high-yield savings account (3.75%). We have now chosen a home and will be using around $18,000 of this money for the down payment. 

I am now worried that I might have to pay income taxes and a penalty for the withdrawal itself. I am extremely anxious over this situation as I feel I have destroyed our family’s financial future and that we cannot afford to pay taxes on the money I withdrew. 

My main concern or question is, is there a way to tell the IRS that this money is being used toward a house? Retroactively? 

See: I’m a single dad maxing out my retirement accounts and earning $100,000 — how do I make the most of my retirement dollars?

Dear reader, 

The first thing you need to do: Take a breath. Most decisions should not be made in a panic, especially when money is involved. 

Because you withdrew from your 401(k), yes, you will have to pay taxes and a penalty. Had it been a loan, you’d have to pay interest on what you borrowed, but it would be to your own account. Keep in mind, however, that loans from your employer-based retirement plans are also risky — if you were to become separated from your job, for whatever reason, you’d be responsible to pay it back or it would be treated as a distribution.

I understand your sense of urgency in wanting to buy a home during a more favorable market, but your time now should be spent on getting yourself financially situated and saving for the future. 

“I wouldn’t advise this or [have] done it this way, but he’s not stuck and it’s not detrimental — it’s just a tough lesson to learn,” said Jordan Benold, a certified financial planner at Benold Financial Planning.  

Get very serious about your current finances and find a way to earmark a portion of your income to savings if at all possible.

There are a few things you should be doing. 

First, assess how much you will be paying in taxes and penalties. I’m not sure what your tax bracket is, but did this distribution push you into a higher tax bracket? You can use a calculator or talk to an accountant to see what that withdrawal will incur in taxes — then make sure you can pay it, or talk to the Internal Revenue Service about an extension. There are penalties for failing to file your taxes or pay them, and that would only add to your stress. 

Also see: We have 25 years until retirement and are saving 25% of our income – are we doing it right? And are we saving too much?

The IRS may not be able to do anything for you in terms of waiving those penalties — though it doesn’t hurt to ask, even if you have to wait on the phone for a while to talk to someone — but communication and attention to detail are key when it comes to your taxes. Getting an IRS agent on the phone and talking through your situation won’t be time wasted. There are so many rules, and an agent can help make sense of your options.

Read: The days of IRS forgiveness for RMD mistakes may soon be over

Once you get that sorted, look extremely carefully at whatever money you have coming in and what’s going out. You’re about to close on a home, and that costs money — not just for the property itself, but all of the extras associated with closing. You may also need money for insurance, furniture, any repairs and so on, so make sure to work that into your budget as you sign the papers. Beyond that, list every expense you expect to have for the next 12 months — home insurance and taxes, a mortgage or utilities, groceries, medicine and any other nonnegotiable costs, and add it all up. Don’t forget anything — ask your partner if there’s anything you may have forgotten. 

Then compare it to your income. Are you under? Are you over? What changes can you make without totally draining your happiness? I always advocate for a balance — in some cases, yes, you have to omit a few expenses for the time being when building up an emergency savings account or paying down debt, but don’t completely rob yourself of joy or all of your hard work may backfire. If you really need to buckle down, make a separate list of activities and entertainment you can get for free (or as close to free as possible) — walks in the park or on the beach with your partner and child, museums on free days, pot lucks and at-home movie nights with family and friends and so on. 

Want more actionable tips for your retirement savings journey? Read MarketWatch’s “Retirement Hacks” column

Earmark a portion of your income to replenish your retirement savings before you try saving for any other goals. (This is separate from an emergency savings account, and you should have one of those.) You may do that with payroll deductions in your 401(k) or by allocating some of your savings to an IRA outside of the 401(k). 

Take some time to learn the rules of your retirement plans. For example, an IRA allows an investor to take $10,000 out of the account penalty-free if it’s for a first-time home purchase, whereas a 401(k) does not have that exception. It may be too late for that, but there are other perks with various retirement accounts. 

The 401(k) has a higher contribution limit and also comes with the possibility of employer matches (if your company offers it), whereas an IRA allows for penalty-free withdrawals for college. With a traditional IRA, you’d have to pay taxes on the withdrawal, whereas with a Roth IRA you’ve already paid the taxes and won’t have to pay any more for withdrawing from your contributions (you may have to pay taxes on the earnings portion, so follow distribution rules closely).

Remember: You don’t want to make distributions from your retirement savings for just anything. You can borrow money for a home or college, but you can’t borrow money for retirement, so it’s important to protect those accounts. Familiarize yourself with the pros and cons of all accounts so that you can maximize your savings and diversify your withdrawal options when you finally get to retirement. 

So just buckle down, get yourself in order and think of the future. “He’s got plenty of time — 30 to 40 years to work,” Benold said. “This might be a distant memory that he hopes he can forget.” 

Have a question about your own retirement savings? Email us at HelpMeRetire@marketwatch.com

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