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Should You Save First for Retirement or a Down Payment on a House?

Last week, a long-time reader e-mailed a superb question: If you must choose, should you save first for retirement or save for a down payment on your first home?

Obviously, both are important. The younger you are when you start contributing to a 401(k) or IRA, the longer compounding interest will work its magic. At the same time, many of us want to own a home before we turn a certain age, get married, or have kids. And if we’re able, the money-savvy among us would like to buy our home with a substantial down payment (ideally 20 percent).

That’s no small goal.

But can you save for both retirement and a down payment at the same time? And, if you must choose, which should be your priority? The answer is, of course, complicated, and depends on some individual financial factors. But, in general, save for retirement first.

Emotionally, most us of will want to save for a home first. Even if we’re being pragmatic and saving a down payment, a home is tangible, a Roth IRA is not. Financially, however, saving for retirement before a home is the right move.

Historically, over 20-25 years or more, stock market gains far outpace real estate. (And, as an aside, I don’t believe anybody should buy their primary residence as an investment. Yes, professional real estate investors have made fortunes, but it doesn’t mean you will—especially on your own home. Buy your house to live in. Period.)


Let’s say Jane Investor saves $6,000 a year for five years before turning 25. For the simplicity of this example, Jane tucked the money under her mattress and didn’t earn any interest during that time. Jane has $30,000 to use as a 20 percent down payment on a $150,000 home or invest in a retirement account that will earn an average of seven percent annual returns over the next several decades.

If Jane Makes a Down Payment

Jane’s first home turns out to be ample for her needs, and she stays in her home for 25 years. According to the Forbes report linked above, the average increase in real estate prices between 1980 and 2004 was 274%. Using this figure, Jane’s home would be worth $370,500 and the $30,000 she “invested” as her down payment would now be worth $74,100. (Obviously, she would have been making mortgage payments, building equity, and would make more of a profit on her home, but I omit those gains here to focus only on the initial $30,000 down payment).

If Jane Saves for Retirement

Jane decides to pull the $30,000 out from under her mattress and invest. She works with an investment advisor to build a well-diversified portfolio and, together, they adjust it at least every year. (Although Jane continues to put money into her 401(k), she put this money into its own account and makes no more contributions). Her conservative but intelligent investing yields an average seven percent annual return over 25 years meaning her $30,000 is now worth $162,823. (Note that over the same 24-year period in the Forbes article, the S&P 500 gained more than 1,000%. That would make Jane’s investment worth over $300,000). What would that same $30k be worth when Jane turns 65? A cool $449,234.

The Bottom Line

Unless you are very lucky or very skilled, real estate can’t beat the stock market as an investment. Add the tax advantages of retirement accounts, and I think the answer becomes even more clear: save for retirement first.

There’s No Need to Rent Forever

If you’re concerned about renting for longer than you had planned, don’t be. Rent is not wasted money any more than your electric bill is wasted money. You need electricity, you pay the power company; you need shelter, you pay rent.

But all of this doesn’t mean you need to rent forever and put all of your money into the stock market. But you should probably put money towards retirement—especially in tax advantaged accounts—before you start putting away for a down payment. What does that mean? Follow this simple algorithm to determine what you should save for retirement:

  • If your employer offers a 401(k) or 403(b) and matches employee contributions: Contribute the maximum percentage of your salary your employer will match (usually six percent). Then contribute up to $5,000 (if eligible) to a Roth IRA. If you have money left over, save as you wish.
  • If your employer offers a 401(k) or 403(b) and does not match employee contributions: Contribute up to $5,000 into a Roth IRA (if eligible) and any extra either to your 401(k) or for other savings goals. (If you earn too much for a Roth, contribute as much as you can to your employer’s plan).
  • If your employer does not offer a 401(k) or 403(b): Contribute up to $5,000 a year to either a traditional or Roth IRA and save additional funds as you want.

Once you are saving a reasonable amount for retirement (the greater of the $5,000 IRA cap or 10-15 percent or your salary), feel free to put additional funds towards saving for a down payment. To accelerate your down payment saving, especially when rates at savings accounts are so low, you might consider opening a regular brokerage account and investing some of your savings in the market.

Using an IRA for Your Down Payment

Finally, the IRS allows you to withdraw up to $10,000 from an IRA for a home purchase without paying the standard 10 percent early-withdrawal penalty. There are some rules: the IRS treats a withdrawal from a traditional IRA as income and you must pay taxes. Withdrawals from a Roth IRA for a home purchase are both tax- and penalty-free as long as the Roth is at least five years old.

Although this loophole provides cash-strapped home buyers with an additional source of funds for a down payment, I wouldn’t recommend using it; any money you withdraw now is money that won’t be earning returns, tax-free, for 30 or 40 years.

Do You Need Twenty Percent?

If you follow my recommendation to save for retirement before saving for a down payment, you may be watching your dream of home ownership fade several years into the future. This can be especially true if you live in areas with pricier-than-average real estate markets. (In some parts of the country, $150,000 can buy a very adequate first home; in others, a buyer might have to spend $350,000 or more for a comparable property). Although regional salary differences can make up some of this difference, in these areas cost of living typically jumps faster and higher than pay, according to the Salary.com Cost-of-Living Wizard.

In this situation, you could consider putting less than 20 percent down. (I would still recommend at least 10 percent). If you have been saving for retirement for a few years, have few other debts, and have a responsible notion of how much home you can afford, putting less than 20 percent down on your home shouldn’t be too much of a problem. You’ll need to pay private mortgage insurance (PMI) for as long as you have less than 20 percent equity in your home, but over the long-run the gains your retirement account is making will make up for the money spent on PMI.

What do you think? Do you agree or disagree that saving for retirement should take precedence over putting away for a down payment? What did you do? Are you happy with your decision? Please weigh in with a comment.

Published or updated on February 22, 2010

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.


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  1. J-man says:

    Everyone has a different strategy and different values and priorities. I live in a “$350+ starter home” area of the country. So I bought a $150K apartment. Then I bought another apartment and the first one is being rented (being bought with other peole’s money). So now I’m in my late 20’s, living in an apartment, just like all my friends, but I’m building equity on 300k in property acquired over time. I plan on doing this again and eventually getting a house. By the time I retire, the apts (and other properties by then) will be paid off and will be genearating a nice cash flow in my retirement. Am I being unrelaistic with this approach? I’ve crunched the numbers but it’s tough to say if I’d be better of just betting the stock market. I see the merit in both. I still put a good % of my income into my 401k, but I feel you need to be careful not to over do it. Please provide comments. Thanks.

  2. Pyro says:

    I’d really have to hit the spreadshit and or calc, but PMI is really quite expensive, and if you were to contribute the cash you’d save not paying PMI and investing it I’m not sure that would be the best way to go. I did go the house route rather than retirement first, but my mortgage is a bit less than a comparable rent.

  3. Zach says:

    Well at 25 I have a Roth IRA for a couple years now, so I guess I chose retirement. To be fair, I was aware I could withdraw on my Roth IRA for a down payment on a house before I opened it.

    I do have my regular brokerage account, which is just about increasing wealth, but I imagine down the road I would like to apply that money to a home. But I do not have an official Save for House type of account.

  4. David Weliver says:

    I appreciate the points so far, thanks guys!

    Though I did write this post in favor or saving for retirement, I do support the “happy medium” approach and understand the emotional connection to home ownership, although I think people often get blinded by the emotions involved in home ownership and forget some of the drawbacks, e.g., the maintenance and the commitment. Similarly, Sara you mentioned saving a bit more is “putting me behind my friends in terms of buying a house”. If we’re not careful, first home buying can lead to a case of “keeping up with the Jones’”. If all our friends own, we wonder what we’re doing wrong renting. We should all be careful to base the decision to buy a home on whether it’s what we want and whether it makes financial sense for US.

    A final note: The reader who asked this question crunched some numbers reminded me of something that tips the scale in favor of buying a home earlier (even, or perhaps especially, in an expensive market): the fact that you can deduct mortgage interest on your income taxes. He calculated that on a $417k mortgage (he’s in San Francisco, one of the priciest markets around) the tax deduction would be about $7500 a year, or $600 a month.

  5. Sara says:

    I agree with you -saving for retirement while young is so smart… However, I can’t WAIT to have a house!!! Like Crystal said, there is definitely emotion involved and I can’t wait to have that comfort and security. (And to decorate!)

    HOWEVER, I just can’t deny that saving for retirement early on will have huge rewards and therefore I contribute my 401k beyond my match and max out a Roth IRA every year.. Then, I use whats left to pay off student loans, and once those are gone to save for a 20%+ downpayment.

    It is definitely putting me behind my friends in terms of buying a house, but I know I’ll be very thankful in the future and it will be worth it. Not only will I feel secure in comfortable in a home, I’ll feel secure in comfortable with my finances which is even more important!

    PS- As far as renting, what I pay in rent is what my friends pay on property taxes. That is just one of the many ways how I justify renting is NOT wasted money!

  6. Crystal says:

    I agree with much of your post however I think for most people there should be more of a ‘happy medium’.

    I never would have been able to purchase a home if I had to contribute fully to a 401k and max out my IRA. I agree you need to ALWAYS take free money from your company in the form of 401k match but doing that and fully funding an IRA every year is not practical for many (wanting to buy a home or not).

    Contributing the full matching percent with your company’s 401k should be your top priority, period. But, after that point, I believe saving should be split between down payment and IRA contributions.

    You forgot about the emotional aspect that many homeowners feel. Owning your own home is less about dollars and cents and more about the comfort and security the people feel. To a lot of people that is more important than a number on a statement.

    (I do need to to say that I am a CPA and a real estate agent.)

    • happymom says:

      My husband & I are now contributing 100% to his 401k & 100% in a traditional IRA & 1k/month for mutual funds.
      We are now paying $2700 for rent. We dont have any existing debt. We are pretty much debt free and financial independent. Do you think we should consider buyng a house? Just scared of being a slave or not having a life once we buy a house.

  7. moneyhoneysf says:

    I think a balance is important. Both paying down the mortgage to avoid having to pay too much on interests and saving for retirement are both essential.

  8. I see retirement savings as my first priority, of course, ideally I’d have a nest egg and a paid off home by the time I’m retire. One reason is that it’s harder to work up the motivation to save for retirement… (I wrote about it here, too).

  9. Ryan says:

    I’m right on the verge of purchasing my own home and this was a great article. Living in CA I’m in the 350,000+ category and there is a lot of consideration when talking about those kinds of numbers.

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