Background

• Internal Revenue Service guidelines prohibit a person from pledging the balance of any retirement account as collateral for a loan. These guidelines are very specific, and they view pledging an amount from a retirement account as collateral for any type of loan as a withdrawal or distribution from the fund for the amount pledged. This is true regardless of the type of retirement account. A retirement account is any tax advantaged retirement savings plan, such as an IRA of any type or a 401K. The IRS taxes such distributions as income, and you will pay a 10 percent penalty on all funds you withdraw from a traditional IRA or 401k, if you are under age 59 1/2.
  
  

First-time Homebuyer

• If you are a first-time homebuyer, or have not had an ownership interest in your primary residence within the last two years, you may be able to take a withdrawal from a traditional IRA or 401k account without paying penalties. You may withdraw up to $10,000 to qualify for this exemption. The money will still be taxed at your rate for normal income, and must be used for the purchase of a home.
  
  

Special Rules for Roth

• You can always withdraw Roth IRA contributions tax-free and penalty-free. If you want to withdraw the earnings from your Roth IRA, you will need to use the $10,000 exemption to avoid penalties. As for taxes, if you have owned your Roth for five calendar years, you will not owe taxes on the earnings. If you have had your account for less than five years, you will pay taxes on earnings you withdraw for a home purchase.
  
  

Other Solutions

• Even if you are not eligible for the first-time homebuyer's exemption, withdrawing the funds and using them for the down payment on your mortgage rather than using the account as collateral may still be a better idea. You may still owe taxes and penalties on the withdrawal per IRS guidelines, but you will reduce the amount you borrow, and the interest you pay. Many 401K plans also have provisions for loans. You could borrow the money from your account and pay yourself interest as you repay it, avoiding all taxes and penalties.