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The problem with prioritizing housing over retirement

Your home is an important purchase, because it's the place you might live in day in, day out for many years. So it's understandable that you'd want to carve out the maximum amount of room in your budget to purchase a comfortable home.

The problem with the scenario above, though, is that we have a couple looking to take on $60,000 in mortgage costs on a $167,000 salary. That has them spending about 36% of their pre-tax income on mortgage payments alone.

That’s well above the traditionally recommended 30% threshold. And considering that the 30% rule of thumb is supposed to include property taxes and homeowners insurance, spending 36% of your pay on just a mortgage is indeed a risky move.

And that risk only compounds when it also comes with the cost of slashing your 401(k) plan contributions. First, the less money you put into a 401(k), the less income you get to shield from taxes. But also, the less you contribute, the less retirement wealth you build.

The median retirement savings balance among Americans aged 65 was just $200,000 as of 2022, according to Federal Reserve data. Now chances are, that number is currently higher thanks to a couple of years of strong stock market gains.

But even so, using the popular 4% rule, a $200,000 nest egg results in about $8,000 of annual income. Add in the average annual Social Security benefit, which is a little shy of $24,000 per year, and that’s $32,000 in total, which is not a whole lot.

If you stop funding your 401(k), you risk ending up with little savings — and not enough income to live comfortably when you’re older. And while your backup plan could be to sell your home down the line if you’re facing a financial shortfall, homeowners are increasingly opting to age in place.

Last year, 56% of older homeowners said they’d never sell their homes, according to Fannie Mae. And only 15% said they’d consider using their home’s equity for extra money during retirement. So while you might think you’ll be willing to sell your home later in life and use your equity to make up for lost savings, doing so could end up being harder than expected.

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How to strike a good balance

Let’s get one thing out of the way. It’s a dangerous thing to spend more than 30% of your income on housing regardless of what it means for your 401(k).

But let’s say you’re able to stay within that limit by reducing your 401(k) contributions. In that case, you may be able to make things work — but it’s best to try to strike a good balance that has you enjoying a nice home while also not neglecting your nest egg.

As of 2024, 95% of Vanguard 401(k) plans offered an employer match. If your company’s 401(k) offers one, aim to at least contribute enough to its retirement plan to claim your match in full.

When you give up a workplace match, you don’t just forgo those principal dollars. You also give up potential gains on that money.

Another thing is that if you’re going to scale back your 401(k) contributions to buy a home, you should at least make sure you’re equipped with a solid emergency fund. That could mean having enough money to cover three to six months of essential bills or more.

In 2023, 63% of Americans didn’t have the cash reserves to cover an unplanned $400 expense, according to the Federal Reserve. So if you’ll be purchasing a home, you may want to consider a smaller down payment so you can set aside ample funds for emergencies.

You may also want to talk to a financial adviser about how much house you can afford given your financial situation, and also discuss the long-term impact of reducing your 401(k) contributions. A financial adviser can run projections for you and show you how much retirement income you might miss out on by prioritizing a home purchase over your 401(k) so you can make an informed choice.

Finally, you may be able to get the best of both worlds by purchasing your dream home but renting a portion of it out so you can continue to fund your 401(k) at full speed. This solution works if your home has a finished basement, or another separate living area that can be rented out while allowing both you and a tenant to maintain some semblance of privacy.

And a tenant doesn’t have to be a forever thing. It could serve as a temporary solution until your income increases. But it may be your ticket to getting everything you want — the home you love and a retirement where you’re not cash-strapped all the time.

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Maurie Backman Freelance Writer

Maurie Backman is a freelance contributor to Moneywise, who has more than a decade of experience writing about financial topics, including retirement, investing, Social Security, and real estate.

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