The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: genselecus on July 20, 2015, 10:04:54 PM
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All,
I'm in the position of wanting to purchase a home in the next few months. I've identified the apartment (the one I'm currently living in) and I have a confirmed price that has me planning to make the purchase. Unfortunately, I haven't been planning to purchase a home so I don't have enough for the down payment in cash. I have enough cash to put approximately 7% down. So my question is where I should get the other 13%, given that I have a few options. Naturally there are tax implications that I'm somewhat aware of (and learning more), and I'm hoping someone can help me understand the specifics of the taxes. In parallel, I'm developing a spreadsheet that will allow me to run the numbers... all advice and info would be much appreciated.
Sources for the remaining 13%:
1. Taxable investment account - this account has well above the remaining 13% down payment, my understanding is that this is the easy method to understand, I would pay 15% federal tax on the gains and another 11% or so for CA state taxes - total tax rate of ~26% on the gains
2. 401k loan - I can withdraw up to $50k from my 401k and no more than 50% of the value. Maxing this loan wouldn't quite get me to 20%, but would get me very close. That said, removing money from a 401k for a down payment is very frowned upon, and for a reason. I lose money from my 401k for some time, which hurts the future gains. I pay it back, with interest, but I don't really understand how that goes back in. Say I withdraw $40k at 5%, would all of that money go into my account (the principal, plus interest)? If I could pay it back at a rate of 7% (my standard assumption for investment gains), would that mean I wouldn't "lose" money by withdrawing from the 401k? And finally, I recognize that when I pay back the loan, I pay it back with post-tax dollars, which means I do lose there...
3. Roth IRA - I have some money in here, but not enough for the full remainder of down payment. My understanding is that I can withdraw the principal with no issues, since I already paid taxes on it. I'm not sure if I can put my withdrawal back in, and it may complicate matters that my income is high enough such that I'm in the phase down range for Roth IRA contributions (I'm aware of the backdoor Roth).
Anyways, I am in the fortunate position that I'm able to make the 20% down payment, but since I wasn't planning to purchase a home, I have to figure out how to get the money from my other accounts. I would be able to pay back a loan from my retirement accounts in less than 18 months. Thanks, for all the help, and please let me know if I'm missing any pertinent information.
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If you can do a 401k loan, this would be best. You'd only be losing on potential gains while that money is out of the market. Repayments are not counted as contributions, so you can still contribute your full amount. The danger would be in getting separated from your employer and having to repay the entire amount immediately or pay penalties for early withdrawal. How stable is your job?
Second best would be taking from the Roth. You can withdraw your contributions (but not earnings) with no tax penalty. However, if you are above the limit you cannot replenish.
Most people are against 401k loans, however if you have a investment opportunity that you have fully evaluated, I think it can be a smart move.
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As you said, you will be paying the taxes only on the gains. If the gains are not a huge fraction, then the tax bite from selling is probably not too much.
From the tax viewpoint, the 401k loan is a good idea *as long as* you can pay it back. In the worst case, you can withdraw from the Taxable to pay it off again *as long as* the Taxable account has not decreased in value.
From the simplicity viewpoint, if I were in a similar situation I would realize the gains in the taxable.
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The rule about borrowing from your 401k says that you will have to pay back the full balance of the loan within 60 days of your separation from your employer.
But...
Some 401k operators do let you continue to make coupon payments on a monthly basis even after separation. Mine does.
Now, they do charge some loan related fees. So read up on that. Also, my 401k allows me to do extra payments. So you can pay back at a faster pace if you desire to do so.
At the end of the day, it all depends on the opportunity cost and the cost of having less than 20% equity (PMI, etc.)
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You might look into whether you can get a HELOC or piggy back loan to put the funds back into your 401k faster. You might not even need much or any down payment money if you can get the 2nd mortgage done at the same time you purchase.
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If the Roth IRA is 5+ years old and this is a first time home purchase, the gains can also be used, tax-free.
I think this is still the least desirable of the 3, as you'll never be able to replace the Roth money you took out (and lose out on the long term tax-free growth).
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Thanks for all the help!
I'm in a good spot with my current employer so no risk there, but I'm thinking the easiest path of using the taxable accounts is probably the best.