Proposed 401(k) Rule Change Could Help First-Time Homebuyers

The Trump administration is expected to introduce a proposal that could make it easier for first-time homebuyers to access their 401(k) savings for a down payment, without incurring the usual 10% early withdrawal penalty.

What’s Being Proposed?

While full details have not yet been released, the proposal is expected to be announced in the coming weeks. It would allow penalty-free early withdrawals from 401(k) retirement accounts when the funds are used to purchase a primary residence.

Currently, 401(k) withdrawals before age 59½ are subject to a 10% penalty (plus income taxes), with limited exceptions. IRAs, by contrast, already allow first-time homebuyers to withdraw up to $10,000 penalty-free for a qualifying home purchase. This new proposal would extend similar treatment to 401(k)s.

How Might It Work?

Although the mechanics are still being developed, the proposal is expected to include:

• Access to 401(k) funds for first-time homebuyers
• A waiver of the 10% early withdrawal penalty
• A requirement that funds be used for a primary residence

Some officials have also mentioned the possibility of allowing individuals to reinvest home equity into their 401(k), though this idea remains speculative.

Why It’s Being Considered

With average down payments rising from $15,000 pre-pandemic to $30,000 or more today, many younger Americans say that saving for a down payment is the biggest barrier to buying a home. The administration has positioned this proposal as part of a broader effort to ease cost-of-living pressures and address housing affordability.

Potential Benefits

• Faster access to homeownership for younger workers
• Greater flexibility in using retirement funds during peak life events
• Potential long-term wealth building through home equity

Key Considerations and Risks

While the proposal could help some buyers, financial professionals note that it carries important trade-offs:

• Retirement impact: Withdrawing from a 401(k) reduces long-term compound growth.
• Tax consequences: Even if the penalty is waived, income taxes would still apply.
• Market timing: Selling investments during downturns can lock in losses.
• Not a full solution: The proposal doesn’t address broader affordability issues like housing supply or interest rates.

Existing Alternatives

It’s important to note that many 401(k) plans already allow participants to take loans from their accounts—including for home purchases. These loans are repaid with interest and do not reduce retirement balances permanently. However, not all plans offer this option, and some individuals may not qualify or be able to afford repayment.

Legislative Outlook

Because 401(k) rules are defined by the tax code, this proposal would likely require congressional approval. With a closely divided Congress and other competing priorities, passage is far from certain.

Should You Consider It?

If the proposal is enacted, it could be a helpful option for some buyers. However, it’s important to evaluate whether it fits your overall financial situation:

• Do you have other sources for a down payment?
• Will an early withdrawal jeopardize your retirement goals?
• Are you financially ready for homeownership beyond the initial purchase?

The Bottom Line

While the proposal could open new paths to homeownership, it comes with important considerations. As details emerge, it’s important to weigh the potential benefits against the negative affect this can have against long-term financial goals.

If you have questions, please reach out to an LMC professional.