He Pulled $18,000 From a 401(k) for a Down Payment. The $10,000 First-Time Buyer Break Doesn’t Apply

Quick Read

• The $10,000 first-time homebuyer penalty break applies only to IRA withdrawals, not to 401(k) plans, even when the money is used directly for a home purchase.

• A 401(k) hardship approval does not remove the IRS 10% penalty, leaving the engineer with a $1,800 charge plus $3,960 in income tax, or $1,000 more than he expected.

• Buyers should look at IRA withdrawals, 401(k) loans, and down-payment assistance before using a 401(k), since the homebuyer exception cannot be claimed afterward.

• The biggest 401(k) decisions are often made once and never reconsidered: when to roll over, what to invest in, and when to withdraw. That is what the report, 401k & IRA Tips and Answers, is designed to help with, and it is free today. (Sponsor)

Imagine a 52-year-old engineer who divorced several years ago and has been renting since then. He signs a contract for a condo and takes $18,000 from his traditional 401(k) for the down payment. Since he is buying a home again, he assumes the first $10,000 will avoid the early-withdrawal penalty. Because his plan approved the hardship request, he expects the IRS to approve it as well.

More Americans are drawing from retirement accounts early. Earlier this year, Vanguard reported that 6% of eligible 401(k) participants took hardship withdrawals in 2025, up from 5% the year before. Rising home prices are making saving even harder. The Case-Shiller index showed U.S. home prices were more than 2% higher in August than a year earlier, adding to the challenge of building a down payment. For buyers who turn to retirement money, mixing up IRA and 401(k) rules can become an expensive error.

Where the $10,000 Homebuyer Exception Really Applies

Federal tax law lets qualifying first-time buyers withdraw up to $10,000 from an IRA without the usual 10% early-withdrawal tax. But that exception ends there. It does not extend to an employer 401(k), even if the cash is used directly to buy a house.

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Now Available: The 401k Answers Nobody Gives You.

For many Americans, contributing to a 401(k) raises even more retirement questions. Should you roll a 401(k) into an IRA, and when? What happens tax-wise if the rollover check is made out incorrectly? When do required withdrawals start, and how much must be taken?

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In an IRA, the rule would fit his situation. The lifetime limit is $10,000, and the funds must go toward qualified acquisition costs within 120 days. He qualifies as a first-time buyer because he had no ownership interest in a main home during the two years before the purchase. That definition can help renters who once owned a home.

Hardship Approval Does Not Remove the 10% Penalty

His plan may allow money to be released for a home purchase under its hardship rules. But that approval only decides whether the plan will distribute the money. Whether the IRS imposes a penalty is a separate issue under section 72(t), and the homebuying exception is not available for workplace plans.

At age 52, and without any other exception, he owes the 10% additional tax on the full amount. Many people think only the $8,000 above the IRA cap would be penalized, which would mean an $800 charge. In fact, the bill is $1,800.

Income tax comes on top of that. In 2026, single filers owe 22% on taxable income between $50,400 and $105,700. If his taxable income before the withdrawal was $70,000, the entire $18,000 would fall in that bracket, adding $3,960 to his federal tax bill.

The $18,000 withdrawal would leave him with an estimated $12,240 after federal tax and penalty, before any state taxes. The amount that actually reaches closing depends on whether tax was withheld from the distribution. If he withdraws more to cover the tax bill, that additional amount is generally taxed and penalized too. He will need to report the extra tax on his federal return, although Form 5329 is not always required. Setting aside cash now, or increasing paycheck withholding, can help avoid a surprise at tax time.

Timing matters for workers in their 50s. Under the Rule of 55, employees who leave a job during or after the calendar year they turn 55 can generally take money from that employer's 401(k) without the 10% early-withdrawal penalty. At 52, this engineer is too young to qualify. And the exception does not apply to IRAs.

This 401(k)-versus-IRA mismatch is one of several lesser-known IRS rules that can cost retirement savers real money, and we outlined nine of them in a free guide: The Retiree's Tax Trap Map.

Four Funding Options to Compare Before Using a 401(k)

1. Check IRA eligibility first. If you have an IRA, or an old 401(k) from a former employer that can be rolled into one, a $10,000 IRA distribution for a first home avoids the penalty and saves $1,000 compared with taking the same amount from a 401(k). Income tax still applies. Married buyers who both qualify can each take $10,000.

2. Compare a plan loan. IRS rules generally limit 401(k) loans to $50,000 or half of the vested balance, whichever is smaller, with a limited exception for smaller balances. If his plan allows loans and he has at least $36,000 vested with no existing loan, he could potentially borrow the full $18,000 without income tax or the early-withdrawal penalty. He would need to repay it, and the payments could affect mortgage approval. Leaving the job creates another risk if an outstanding loan becomes due and cannot be repaid.

3. Use cash and taxable accounts before retirement money. Selling shares held for more than a year in a brokerage account generally triggers capital gains tax, often at lower rates and only on the gain. A traditional 401(k) withdrawal is taxed in full as ordinary income.

4. Ask about down-payment assistance. State housing finance agencies and some lenders offer grants or forgivable second mortgages to qualifying buyers. Some programs treat people as first-time buyers if they have not owned a home in three years, which differs from the IRA's two-year rule. Income limits and deadlines vary, so check the rules before signing a purchase contract.

For anyone considering this move, the order matters most. Resolve the IRA, loan and assistance options before requesting a 401(k) hardship withdrawal. Once the money leaves the plan, it generally cannot be rolled into an IRA to claim the homebuyer exception. And the extra $1,800 tax bill does not go away just because the withdrawal was approved.

Released: 401k & IRA Tips and Answers

(sponsor) 401(k)s are powerful retirement tools, but even experienced savers can make mistakes that quietly cost money for decades. Choosing the wrong fund, overlooking small fees that add up, or handling rollover steps in the wrong order can all create problems.

This is exactly the kind of mistake that 401k & IRA Tips and Answers was created to help prevent. It is a free Fisher Investments guide covering rollovers, contributions, required withdrawals, and the mistakes that can do the most damage to a retirement account. Learn More Here ›