By Rachel Hartman | USNews.Com
Troy Warren for CNT
If you’re shopping for a new home, you may be looking for ways to fund the purchase. Taking out cash from a retirement account such as an IRA might be an option in some cases. However, before you withdraw money from an IRA, you’ll want to evaluate the short-term and long-term consequences. Use the following criteria to help decide whether to use your IRA to buy a house.
Should You Withdraw From an IRA to Buy a House?
When you open an IRA, the account is established to help you save for the future. Normally you’ll need to wait until you are age 59 1/2 to start withdrawing funds. If you withdraw money from the account before age 59 1/2, you will typically have to pay a 10% penalty on the amount withdrawn. The distribution will also be subject to taxes.
However, there are certain circumstances in which you might be able to take out funds from the account before reaching age 59 1/2 and not incur penalties. One exception to the early withdrawal penalty is for the purchase of a first home. “Although it’s possible, using money in your IRA to purchase a home is generally not advisable,” says Doug Jackson, president of Tennessee Tax Solutions in Nashville, Tennessee. “Accessing large sums of money in an IRA prior to retirement can set you back big time.”
For instance, perhaps you decide to withdraw $5,000 from an IRA to help put together a down payment for your first home. That amount will not have the chance to grow and earn interest over decades. This means you could potentially lose thousands or tens of thousands of dollars that could have been added to your account balance before your retirement.
How to Use an IRA to Purchase a Home
If you decide to take savings from your IRA to put toward the purchase of a home, you’ll first need to make sure you qualify. The IRS allows a withdrawal of up to $10,000 from an IRA to buy a home for the first time. To be considered a first-time homebuyer, you cannot have owned a primary residence at any time during the previous two years. “This $10,000 exception is available for every individual, so a married couple can withdraw $10,000 from each of their IRAs for a total of $20,000 that can be used for a down payment,” Jackson says.
In addition to purchasing your own home, you may qualify to help others buy their first house. “IRA owners can withdraw funds penalty-free to help their first-time home buying children, grandchildren or parents purchase a home,” says Michael Walsh, a wealth advisor at Walsh & Associates in Sarasota, Florida. “However, $10,000 is the lifetime maximum for first-time homebuyer withdrawals.” The total of your withdrawals must remain under the $10,000 mark to avoid the early withdrawal penalty.
While there will not be a penalty on early IRA distributions for a first home purchase, you can expect to pay taxes on the amount withdrawn. For example, if you are in the 22% tax bracket, a $10,000 withdrawal for a home purchase will lead to $2,200 in taxes. For a couple in the 24% tax bracket who withdraws $20,000, the taxes due would come to $4,800.
How to Withdraw From a Roth IRA for a Home Purchase
For those who want to take funds from a Roth IRA rather than a traditional IRA, the rules are slightly different. “You can withdraw money from your Roth IRA before retirement age without penalties as long as the account is at least five years old,” says Dominic Trupiano, the vice president of sales at Artesys in St. Louis, Missouri. You will be able to withdraw any amount up to the total amount you contributed without being subject to taxes.
In addition to your Roth IRA contributions, you might opt to take out some of the earnings in the Roth IRA. “You can withdraw an additional $10,000 from the earnings under the first-time homebuyer exemption,” Trupiano says. Before doing so, you may want to look at calculations to see how your retirement funds could be impacted. “Withdrawing $10,000 from an IRA at age 30 could cost a person $57,000 at retirement, assuming a 6% rate of return,” Trupiano says.
Other Options for Purchasing a Home
Instead of accessing cash from your IRA, you could search for other ways to fund a home purchase. You might withdraw from a different account, such as a short-term savings account, money market account or a 401(k) plan. Some 401(k) plans may allow for a loan to help with a home purchase. “Loans from a 401(k) typically incur no penalty or taxes, but the borrower will need to pay interest on the loan,” Trupiano says. “Similar to the IRA, borrowing money from a 401(k) could potentially hurt retirement prospects.” You may also decide to apply for a regular home loan to help cover the costs of the purchase.