He Withdrew $18,000 From His 401(k) for a Down Payment. The $10,000 First-Time Homebuyer Exception Won’t Apply to His 401(k) Withdrawal

Picture a 52-year-old engineer. He was divorced three years ago and has rented ever since. He signs a contract on a condo and pulls $18,000 from his traditional 401(k) for the down payment. Because he’s a first-time buyer again, he assumes the first $10,000 escapes the early withdrawal penalty. His plan approved the hardship request, so he figures the IRS will go along too.

More Americans are tapping retirement savings early. Earlier this year, Vanguard found that 6% of eligible 401(k) participants took hardship withdrawals in 2025, up from 5% the previous year. Home prices aren’t helping. The Case-Shiller index shows U.S. home prices were more than 2% higher in August than a year earlier, adding to the challenge of saving enough for a down payment. For buyers turning to their retirement accounts, confusing the IRA and 401(k) rules can become a costly mistake.

Where the $10,000 Homebuyer Exception Actually Lives

Federal tax law allows eligible first-time buyers to withdraw up to $10,000 from an IRA without paying the usual 10% early-withdrawal tax. But the exception stops there. It doesn’t extend to a workplace 401(k), even when the money goes directly toward buying a home.

Inside an IRA, the rule fits his situation well. The lifetime cap is $10,000, and the money must cover qualified acquisition costs within 120 days. He counts as a first-time buyer because he had no ownership interest in a main home during the 2-year period before the purchase. That definition benefits renters who once owned.

Hardship Approval Leaves the 10% Penalty Intact

His plan can release money for a home purchase under its hardship rules. That approval only determines whether the plan will pay out. Whether the IRS adds a penalty is a separate question under section 72(t), and the exceptions for workplace plans don’t include buying a home.

He’s 52 and has no other exception, so the 10% additional tax applies to the full amount. Many people assume only the $8,000 above the IRA cap gets penalized, which would cost $800. The actual charge is $1,800.

Ordinary income tax comes on top of that. In 2026, single filers pay 22% on taxable income between $50,400 and $105,700. Suppose his taxable income before the withdrawal is $70,000. The entire $18,000 falls within that bracket, adding $3,960 to his federal income tax bill.

The $18,000 withdrawal leaves him with an estimated $12,240 after accounting for federal taxes and the penalty, before state taxes. How much actually reaches closing depends on any tax withholding from the distribution. If he takes out more money to cover the bill, that extra amount is generally taxed and penalized too. He’ll need to report the additional tax on his federal return, although Form 5329 isn’t always required. Setting aside money now, or increasing his paycheck withholding, can help avoid a surprise when he files.

Timing matters for investors in their 50s. Under the Rule of 55, workers 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 doesn’t apply to IRAs.

This 401(k) versus IRA mismatch is one of several quiet IRS rules that cost retirement savers real money, and we mapped nine of them in a free guide here: The Retiree’s Tax Trap Map.

Four Funding Routes to Compare Before Tapping a 401(k)

1. Check your 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 the same amount from the 401(k). Income tax still applies. Married buyers who both qualify can each take $10,000.
2. Price out a plan loan. Under IRS rules, 401(k) loans generally cannot exceed $50,000 or half the vested account balance, whichever is less, 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 triggering income tax or the early-withdrawal penalty. He would have to repay it, and those payments could affect his mortgage approval. Leaving the job creates another risk if an outstanding loan becomes due and he cannot repay it.
3. Use cash and taxable accounts before retirement money. Selling shares he has held more than a year in a brokerage account triggers capital gains tax, often at lower rates, and only on the gain. A withdrawal from a traditional 401(k) 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 eligible buyers. Some programs consider people first-time buyers if they haven’t owned a home in three years, although that differs from the IRA’s two-year rule. Income limits and application deadlines vary, so check the requirements before signing a purchase contract.

For anyone considering this move, the order matters most. Settle the IRA, loan and assistance questions before requesting a 401(k) hardship withdrawal. Once that money leaves the plan, it generally can’t be rolled into an IRA to claim the homebuyer exception. And the extra $1,800 tax bill doesn’t disappear because the withdrawal was approved.

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