Dave Ramsey Says You Should Never Use Your 401(k) For This Kind of Payment

Investing through a 401(k) can be a smart move. The account is usually tied to an employer, though independent contractors can also open their own 401(k) and take advantage of the tax benefits built into this retirement strategy. According to Capitalize, nearly 60% of U.S. workers had access to a 401(k) through their job by the end of 2023.

In addition to the chance to invest money before it is taxed, many employers also provide matching contributions, which adds free money for employees to put toward their future. It is also possible to borrow from a 401(k) or take an early distribution. Those moves can help in severe financial emergencies, but they should never be treated casually. Dave Ramsey, best known for his 7 Baby Steps money plan, strongly advocates maximizing retirement savings. He has also warned against one specific reason for tapping a 401(k): paying for a home purchase.

A caller on Ramsey’s show once asked whether she should withdraw money from her 401(k) to buy a house. She explained that her rent had gone up and was no longer affordable, and she had started considering using retirement savings to secure a home for her family instead. Her goal may have been understandable, but Ramsey argued that the move would create far more risk than she realized.

Taxes and penalties can take a big bite

The immediate cost can be severe. If you take an early withdrawal, you generally owe income taxes on the money, plus a 10% penalty. Because income taxes are progressive, the extra withdrawal can also push part of your income into a higher tax bracket. In the caller’s situation, Ramsey said she should expect to lose roughly half of the distribution’s value to taxes and penalties.

Borrowing from a 401(k) is another possibility. A loan lets you access the money without the penalty or immediate tax bill. However, you typically have five years to repay the amount, along with interest, or the loan is treated as an early distribution. If you use a large portion of the account for a major purchase such as real estate, you could end up facing a double burden: repayment pressure now and a tax problem later if you miss the deadline.

Early withdrawals can damage long-term growth

Whatever the reason, pulling money out of a 401(k) creates another problem beyond taxes and penalties: it interrupts the account’s long-term growth. Regular contributions and time are what allow investments to compound and build for retirement. Taking money out slows that process, and in some cases can stop it altogether. Replacing the lost ground may require much larger contributions, but annual contribution limits can make that difficult even for disciplined savers.

A 401(k) loan can also create setbacks on some plans. While the loan remains unpaid, you may be unable to contribute to the account at all. That means using the plan this way could reduce your ability to save for years. The harm may not be immediate, but the lost compounding can force you to work longer or lower your standard of living later in life to recover the missed growth.