Should I take a hardship withdrawal from my 401(k) for a down payment?

[Edward Stephens]

Dear BP Community,

I am actively looking to purchase both units of a duplex, live in one unit and lease one unit (house hack). I found a property that I'm considering making an offer on, and I'm analyzing different ways to pay for the down payment and closing costs. The property is listed at $180k and I'll be applying for an FHA loan (@ 3.5% down + closing costs = $10k).

I have the money in my bank savings account now to make the down payment, or I could use my traditional 401k to fund the purchase. I’m not allowed to take out a loan on my 401k per my plan’s rules, but I can take a hardship withdrawal to cover closing costs and a down payment. Once I take this hardship withdrawal, it is my understanding I cannot ever take another one for any reason (is this true?). The penalty for a hardship withdrawal is 10%. I also have to pay taxes on the funds, although I’ll defer the payment of all these taxes until tax season next year. I can use the money in my bank savings to help me purchase my next investment property in December (I won’t live there), which I anticipate will require a 20% down payment. Also, I won’t be eligible to use a hardship withdrawal to fund my December purchase.

My questions are: (1) Have you ever taken a hardship withdrawal from your 401k to fund a down payment and closing costs? (2) Do you foresee any problems using the 401k hardship withdrawal to purchase both units of a duplex? (3) Is there anything you think is significant that I haven't considered on this deal? (4) Will the use of my 401k funds inhibit me from holding the entire property in an LLC?

One thing I didn’t mention above- I won’t be eligible to contribute to my 401k plan for 6 months after my hardship withdrawal, but I’ve stopped contributing to it anyhow after reading a half dozen Rich Dad Advisor Series books.

Thanks in advance

[Brandon Hall]

@Stephen D.

Many plans do not allow you to take out loans, which the OP mentioned, as the cost to add that feature is not worth it to smaller businesses. 

@Edward Stephens

I can tell you from my experience in dealing with clients with various financial positions that a 401(k) early withdrawal is generally not a good idea. It's simply too costly, and if you are a first time investor, you need to focus on building your wealth, not cutting it. 

I typically ask someone in this situation what their income vs. spending looks like and whether or not they adhere to a budget. It's generally better to tighten the reigns on the spending and delay your real estate investing goals while you build up various savings and reserves. 

The problem is that your 401(k) withdrawal is going to be very expensive. You are going to pay your marginal tax on the money, the 10% penalty, and you will have foregone earnings. Easily enough, the withdrawal could cost you over 40%. That's insane.

I'd recommend trying to find another source of money to utilize or figuring out how to earn and save more. Don't touch the 401(k). That should be an absolute last resort option if life knocks you down and generally should not be used to purchase a rental.