Homebuilders Are Slashing Prices as Confidence Drops to a 14-Year Low. A First-Time Buyer Withdraws $10,000 From a 401(k) and Learns the IRS Exception Doesn’t Apply

Builders are lowering prices and showing more willingness to negotiate, which tempts a first-time buyer to dip into her 401(k) to fill a down payment shortfall while assuming a tax break will soften the blow. The IRS disagrees.

A 35-year-old renter browsing new-home listings this fall might notice a welcome shift: builders are suddenly more open to cutting deals. The National Association of Home Builders says 43% reduced prices in October, the biggest share since 2020, with the average discount remaining at 6%.

The reason is simple. In its Oct. 19 report, the association said builder confidence fell to 29, the weakest reading in 14 years. Traffic from prospective buyers was also at its lowest level since April 2012, if the initial pandemic shock in April 2020 is excluded.

A Sample Buyer Turns to Her 401(k)

Consider a hypothetical buyer: 35 years old, unmarried and still working, well below the age at which retirement withdrawals can generally be taken without penalty. Her income places her in the 22% federal bracket, which for single taxpayers in 2026 begins at $50,401 of taxable income.

Her plan allows hardship withdrawals for a principal residence, and she qualifies. She asks for $10,000 from her traditional 401(k) to help cover the rest of her down payment. She is expecting a familiar first-time-homebuyer tax break that lets people withdraw $10,000 early without the 10% penalty. What she does not know is that the exception applies to IRAs, not 401(k)s.

Why the IRS Exemption Does Not Cover Her 401(k)

The IRS allows eligible first-time buyers to take up to $10,000 from an IRA without the 10% early-withdrawal penalty. The exemption is a lifetime limit, and the funds generally must be used for qualifying homebuying expenses within 120 days. It does not extend to 401(k)s, and it does not eliminate ordinary income tax on the withdrawal.

Federal tax rules usually add a 10% tax to retirement withdrawals taken before age 59½ unless an exception applies. A hardship withdrawal may give her access to the money, but it does not erase that penalty. Some exceptions do apply to 401(k)s, including leaving an employer during or after the year you turn 55. None of them fit this 35-year-old first-time buyer.

What the $10,000 Withdrawal Leaves Her With

Because the money was contributed pretax, the entire $10,000 is treated as ordinary income. If the full amount falls within her 22% federal bracket, she would owe $2,200 in income tax, plus another $1,000 for taking the money out early.

After those taxes, she would keep $6,800 before any state income tax. To end up with the full $10,000 after federal taxes, she would need to withdraw about $14,706, assuming every extra dollar is taxed at the same 32% combined rate. Roughly $1,471 of that larger withdrawal would be owed solely to the early-withdrawal penalty.

The long-term cost is even steeper. If that $10,000 remained invested and earned an example 7% annually, it could grow to about $76,000 by age 65.

Less Costly Ways to Fill the Gap

Using money already set aside can avoid the tax hit from a retirement withdrawal, as long as she still keeps a sensible emergency reserve.

A 401(k) loan, if her plan permits one, avoids both income tax and the 10% early-withdrawal charge as long as repayment rules are followed. But it creates a new monthly payment, usually made from after-tax dollars, and the borrowed funds are no longer invested. If she leaves her job, the plan may require the remaining balance to be repaid. If not, the unpaid amount could be treated as a taxable distribution and may trigger the 10% tax. Certain rollover deadlines can offer relief for eligible loan offsets.

Rolling money into an IRA could open the door to the first-home exception, but her current employer’s plan generally will not allow her to roll over salary deferrals while she is still employed there at age 35. An old 401(k) from a former employer creates another path. She could roll eligible funds directly into a traditional IRA and then withdraw up to $10,000 for qualifying homebuying costs without the 10% penalty. Ordinary income tax would still apply, and a hardship withdrawal already taken from her current plan cannot be rolled over afterward.

Run the Numbers Before You Sign

Before requesting a distribution, check whether you have an old employer 401(k) that could be moved into an IRA. Confirm that you qualify for the first-time buyer exception and can meet the 120-day deadline. Then compare a 401(k) loan with the potential $3,200 federal tax bill from a hardship withdrawal, including what happens if you change jobs before the loan is repaid.

Finally, weigh the savings against the cost. On an example $400,000 home, a 6% price cut would save $24,000, matching the average discount reported by builders who lowered prices in October. That is a meaningful bargain, but a $1,000 early-withdrawal penalty still chips away at the savings and leaves a smaller retirement balance behind. Builders may be open to negotiating, but the IRS still draws a clear line between 401(k)s and IRAs, no matter how good the home price looks.