Expanding Retirement Savings to Promote Homeownership - or Do Away with Interest Deduction

What if 401(k) accounts, the popular employer-based retirement savings plans were reordered to provide an incentive and a vehicle for providing homeownership?  That proposal, made last fall in a paper published by the Progressive Policy Institute has just gotten a tweak its authors may not have intended.

So-called HomeK Accounts were suggested by Jason Gold and Anne Kim, both senior fellows at the Institute in a paper titled HomeK Accounts:  A Down Payment on Homeownership and Retirement.  As they envision them individuals would have the option to segregate up to 50 percent of their pre-tax contribution to a 401(k), IRA, or SEP into a housing-specific subaccount with a lifetime pretax cap of $50,000.   The remaining 50 percent or more of the individual contribution and 100 percent of any employer contribution would be treated as retirement savings exactly as it is now.  

The HomeK money would be available for a one-time disbursement for a down payment to purchase a first-time home conforming to current limits for an FHA loan in the local area.  The disbursement would be taxed at a marginal rate of 5 percent for individuals with less than a $75,000 adjusted gross income or $150,000 for a couple and 15 percent for those in the next higher bracket. No benefit would be available for individuals with incomes over $125,000 or couples over $250,000.

To prevent abuse the buyer would have to purchase the home as a primary residence and would not be allowed to increase the loan amount for two years.  There would also be a one-year "vesting period" from the date of the first-set aside before a buyer could withdraw money from the account.

If the buyer wished to terminate the subaccount or did not use the entire amount for a down payment, the balance in the account would revert to a regular retirement savings account without penalty.

Gold and Kim point to a number of potential benefits from the program.  First, many first-time buyers already use retirement funds for a down payment and this plan would eliminate the current substantial tax and penalty attached to an early withdrawal and avoids the downsides to borrowing from it.  These include a higher interest rate and complications if there is a change in employment before the loan is repaid.  

Second, it would boost first-time housing demand which is a lynch-pin of the housing market and would stimulate that market and the economy in general.  It would also increase the number of first-time buyers who buy with meaningful down payments and thus encourage "responsible" homeownership.  Finally, it would encourage greater participation in retirement savings.  The authors point out that retirement is often far from the minds of young workers but home ownership is not.  Using retirement savings as a mandatory part of the program encourages one goal while achieving the second. 

Gold and Kim point out that HomeK accounts would not add to the complexity of the tax code (although it is not clear whether the addition of these accounts would require Congressional action) and would have little cost to the government.  The only expense would be the difference between the low tax rate paid on an early withdrawal of funds and the higher tax rate which might ultimately be paid by the beneficiary post-retirement.

The paper belatedly caught the attention of Jordan Weissmann, an associate editor at The Atlantic.   In an article on July 18, he spun off of an earlier Atlantic article strongly criticizing the present home mortgage interest tax deduction on several fronts including its cost and took the HomeK idea to a different place; using it to replace, at least partially, that deduction.

Weissmann notes that "What's broadly neat about [the HomeK] concept is that it flips the incentives for home buyers in a much needed way."  The interest deduction, by delaying the impact of the buying decision, he said, actually encourages borrowers to take out larger mortgages and perhaps buy too much house.  The subaccounts suggested by Gold and Kim would encourage workers to make larger down payments because that is where the savings will be.  Weissmann admits that swapping the accounts for the deductions might delay homeownership for some people but it would make it a safer and more responsible investment for them once they were able to make it. 

He says that one downside to the proposal is that not every worker has a 401(k), but data indicates that these people are not taking advantage of any mortgage deductions anyway.  Finally Weissmann suggests that perhaps the mortgage deduction could be limited (by household income or by maximum loan value?) and combined with the savings accounts "to try and get the best of both worlds."