Using An IRA Or Roth IRA For First-Time Homebuyers

Using a Roth IRA for a First-Time Home Purchase

While the primary purpose of a Roth IRA is for retirement savings, it has a provisions for early withdrawals that are exempt from penalties when there is “immediate and heavy financial need”. Costs directly related to the purchase of a primary residence is a qualifying exemption, according to the Internal Revenue Service. Other qualifying exemptions include medical costs, tuition, payments to prevent eviction, funeral expenses, and damage to a principal residence.

Rules for Withdrawing Roth Contributions

• The home must be considered a ‘first-time’ purchase.
• The qualified early withdrawal would be both tax and penalty-free.
• The amount any individual can withdraw penalty-free from Roth IRA funds to purchase a home is limited to $10,000 per individual (thus $20,000 if your spouse also withdraws from their IRA).

Since contributions to a Roth IRA are made after-tax, they are treated differently from traditional IRAs and can be withdrawn from the Roth account at any time without paying tax on them again. Earnings on those contributions, however, are different.

Note: When you reach the age of 59 ½, you become eligible to withdraw IRA money for any purpose penalty-free.

Rules for Roth IRA Withdrawing Earnings

Earnings from a Roth IRA are eligible for withdrawal with no taxes or penalties once the account holder turns 59½ and the assets have been in the account for at least five years. Withdrawals of earnings not meeting both of these criteria are subject to tax and penalties.

Note: Withdrawals from a Roth IRA are assumed by the IRS to come from contributions first, then transfers, and finally earnings.

Using a Traditional IRA to Buy a House

The same qualifying exemption for using Roth IRA funds to buy a house also applying to using traditional IRA funds, but the withdrawal penalties and restrictions differ.

Individuals with a traditional IRA who are under 59½ years of age can use up to $10,000 for the purchase of a home, provided they have not owned a home in the prior two years. Individuals over age 59½ are permitted to withdraw any amount of money from a traditional IRA to purchase a home, even if they did own one in the past two years. Either way, both individuals have to pay ordinary income tax on the money withdrawn.

Qualifications & Eligibility for Using an IRA

To withdraw money from a traditional IRA prior to age 59½ toward the purchase of a home, account holders will still pay income tax, but will not pay penalties if:

• It is a first-time purchase (no homeownership in the prior two years)
• It is $10,000 or less
• It is not a mortgage payment

Income Tax Considerations

The total amount of withdrawals from a traditional IRA are subject to ordinary income tax, regardless of the account holder’s age.

Using a 401k to Buy a House

A 401k plan can also be used to provide needed cash to purchase a home. As with traditional IRAs, plan participants over the age of 59½ can withdraw money for any purpose, though it would be taxed as ordinary income. Under the age of 59½, the participant can apply for a hardship withdrawal, which must be approved by the plan sponsor. Hardship withdrawals, if approved, are subject to taxes but not penalties.

Another option, however, is available for taking advantage of assets in a 401k plan is a 401k loan. Plan participants are permitted to borrow funds from their own plans in most plans if they commit to a payment schedule of no more than five years and a commensurate interest rate. Loan repayments are typically made through salary deductions. Loans can be made this way for up to $50,000 or 50% of vested assets, whichever is less.

Cashing Out an IRA for a Rental Property

While buying a primary residence is listed by the IRS as a valid withdrawal exemption in IRAs, withdrawing money early to purchase investment real estate is not and would subject you to taxes and penalties.

However, a seldom known fact is that the IRS does not prohibit the purchase of investment real estate inside an IRA as long as it is not for personal use.

Your IRA would need to have sufficient assets in it to make the purchase. Generally, this is something for larger IRAs and you would need to identify a custodian who is equipped to handle the recordkeeping, but there are more than a dozen in the US now who can do so. You would also be unable to live on the property yourself.

Is it a Good Idea to Use an IRA or Roth IRA for a House?

Arguments can certainly be made that using IRA assets to help purchase a home might enable some people to make a home purchase they might otherwise not be able to afford. After all, a home is also a long-term investment and the gains on a home can sometimes receive more favorable tax treatment than those in an IRA (long-term capital gains rates and perhaps some tax exclusions).

Nonetheless, sound financial planning might also conclude that homeownership could result in unexpected maintenance and repair or other financial risks that might leave someone in a difficult position. In addition, spending IRA money on a home removes that money from retirement savings or from being used as a safety net in the case of an emergency such as a major health issue.

The bottom line is that using IRA money for a home purchase may not make sense for everyone and serious consideration should be given to both the pros and cons before making such a move.

How to Withdrawal from a Roth or IRA for a Home Purchase

Making an early withdrawal from your traditional or Roth IRA involves making the request through your IRA administrator or custodian, which can often be done online. Before you can withdraw funds, they must also be available in cash, so you may need to liquidate some of the investments you have inside your account.