1) I understand why it's bad to withdraw from your retirement early; my wife and I need to purchase a house and the money will be better suited being used now. The money used as a down-payment will save us plenty of money in compound interest overtime along with allowing us to buy the home we desire. (No, unfortunately it is not our 1st home) 2) The majority of the money is made up of Roth contributions while the rest is pre-tax earnings.
First of all, the Roth funds rolled from a 401(k) will be subject to a "new" 5 year restriction. So any earnings that you withdraw will be subject to taxes and penalties.
Second, pre-tax would be subject to taxes and penalty (assuming you are younger than 59 1/2).
You might want to re-think your logic.
Money is extremely cheap right now. You can lock in an interest rate for 30 years at 4% or so. Yes a bigger down-payment will reduce the interest you pay, but it will also reduce the investment income you earn...which could be a bigger number.
Also, don't neglect liquidity. If you tie up all your money in your house, what will you do if have a large expense? The reason so many seniors need reverse mortgages is because they tie up all their funds in the house.
Those are good points from others.
I would just add a comment here: If you and your wife have not owned a home for more than 2 years, then technically your next home purchase would qualify as "first time home buyer," according to the IRS's definition. In that case, distributions up to $10k (or $20k with your wive's IRA) would be penalty free, albeit still taxed. A big difference between a house and an IRA investment, from a return's standpoint, is that with a house, you can leverage it (ie, mortgage). So if the housing market continues to do well over the coming years, then your investment return may be significantly higher than in an IRA. Of course, the downside holds too whenever you have leverage.
First, others are correct in that in a strictly financial sense you may be better off having a larger loan instead withdrawing from your Roth 401k. If the retirement money is managed correctly, it should be able to earn more interest than the after-tax interest cost of the mortgage.
One clarifying point that I have not seen in previous posts is that there is no tax or penalty on your Roth 401k contributions. You would only have to include the earnings from your investment, if any, as taxable income. This would also be subject to the potential 10% penalty.
In conclusion, you can withdraw up the amount of your contributions with no tax and penalty; however, it still may not be the right thing to do financially.