Charlotte man says his 'full of crap' ex-wife wants him to cash out his 401(k) to buy a home, but Ramsey Show hosts warn he'll face huge penalties

Ramsey and co-host George Kamel responded with a firm no. Their reasoning went beyond the risks of the housing market. Cashing out a 401(k) comes with heavy penalties, taxes and a major loss of compound growth.

Here’s the breakdown on why sacrificing your future for a house today is usually poor planning and whether there are any situations where tapping your retirement savings makes sense.

Ryan’s limited retirement savings

“Why would anyone ask their ex-wife for financial advice?” Ramsey joked, adding he was “so confused” by Ryan’s reasoning.

Ryan’s situation was also more precarious than it sounded. While it might seem like he had a large balance to consider cashing out, he told the hosts he has only $85,000 in his 401(k) despite earning $130,000 a year at age 50. That puts him well behind the typical savings target for his age, which is about six times his income, and below the average 401(k) balance for his age group, which is $313,220, according to Edward Jones (2, 3).

Ramsey didn’t mince words about the risks of pulling money from a retirement account to buy a home.

“When she cashed out half of that 401(k), she got charged a 10% penalty plus her tax rate. She borrowed that money at 35% interest,” Ramsey said. “By the time she flipped that house and made money, she didn’t even make money.”

When Ryan pushed back, saying he saw what she made from the sale, Ramsey cut him off.

“You didn’t see all the penalties and taxes she paid on the stupid withdrawal from the 401(k) that negated any profit she made on the flip,” Ramsey said. ”She’s so full of crap, she’s a Christmas turkey.

“If you cash out your money, they’re going to charge you a 10% penalty plus a 25% tax rate,” he added. “That’s like saying, ‘Dave, I want to borrow at 35% interest to buy a house.’ Please don’t do that.”

Why early withdrawals hurt your wealth

Withdraw money from your 401(k) before the age of 59 1/2 and you’ll pay your normal income tax rate plus a 10% early withdrawal penalty (4). That often means losing 30% to 40% of what you take out. That’s why Ramsey compared to taking out a 35% mortgage.

Because of these penalties, financial experts say early withdrawals should be a last resort. They’re usually recommended only when someone has no other assets to tap and cannot qualify for a lower-interest personal loan or line of credit.

There are a few situations where you can withdraw from a 401(k) without paying the penalty, including certain hardship withdrawals for medical bills or emergency home repairs, but the rules are strict and you still owe income tax. Some 401(k) plans don’t allow early withdrawals at all.

There’s also the “Rule of 55,” which applies to workers who leave their jobs in the year they turn 55 or later. It lets them withdraw from the 401(k) tied to their most recent employer without the 10% penalty, though the money is still taxed.