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Can You Use Your Roth IRA to Buy a House?

April 26, 2022
8
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A Roth IRA offers a way to use funds before retirement for large expenses like a home, avoiding an early withdrawal penalty. Although there are risks associated with it.

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Individual retirement accounts (or IRAs) are savings accounts designed to help people save for retirement. Unlike a 401(k), these are not tied to an employer. There are many types of IRAs, each with their own rules governing eligibility, contribution limits, taxation, and withdrawals.

Although an investor might intend to use Roth IRA funds for retirement, life can get in the way. Buying a home usually is one of the biggest financial events in an investor’s life, and given rising housing costs and mortgage rates, some investors may consider dipping into retirement funds to make their down payment.

Can you use your Roth IRA to buy a house?

The IRA does permit withdrawals from Roth IRAs to purchase a home. It’s one noted exception to rules on IRA withdrawals in which one can tap retirement savings to fund something other than retirement. 

For most IRAs, if someone withdraws any money from their tax-deferred IRA account before the age of 59 1/2, they may incur a 10% early withdrawal penalty, and may have to pay income taxes on the distribution, which refers to the payout or withdrawal of funds. However, Roth IRAs work differently, because of how they are taxed. 

Roth IRAs are funded with after-tax dollars—meaning an investor has already paid income tax on the money they contribute to the account. Investors are therefore free to withdraw any and all of their original contributions to fund a home purchase, without penalty or taxes. But when withdrawing investment gains that that money has earned, investors must observe a $10,000 limit. If an investor withdraws more than $10,000 of gains, they face penalties and taxes. 

For example, if an investor contributes $25,000 in a Roth IRA and it grows to $35,000, there is $25,000 in contributions and $10,000 in earnings. They could withdraw from a Roth IRA for a home purchase and take out the total amount of $35,000, which includes the maximum of $10,000 in earnings. 

Roth IRA withdrawal rules for home buyers 

Investors must meet certain conditions in order to make a Roth IRA withdrawal for a home purchase without penalty.

Qualifying rules

There are some rules before an individual can qualify to withdraw from their Roth IRA to purchase a home without penalty. These include:

  • The Roth IRA must have been created and funded at least five years ago or more. 
  • The home must be considered a first-time home purchase. The IRS’s definition of this is lenient, defining this as not having owned a home for at least the past two years. So if an individual owned a primary residence four years ago, sold it, and rented for a while, they may qualify as a first-time homebuyer, even though they’ve previously owned a home. 
  • The funds must be used for qualified acquisition costs, which can include down payments, closing costs or financing as well as costs related to building a home. 
  • The money can be used toward a home purchase for yourself, spouse, child, grandchild, parent, or ancestor. 
  • The funds must be used within 120 days of withdrawal from the Roth IRA. 

Other Roth IRA withdrawal rules

Married couples are able to withdraw up to $10,000 in investment gains each. But both parties must also meet the eligibility requirements for first-time homebuyers. In other words, neither person may have owned a home for the previous two years. 

The $10,000 maximum withdrawal of earnings is what’s allowable for a lifetime. That means investors can’t do this repeatedly to fund multiple home purchases. 

Contribution rules

Not everyone is able to contribute to a Roth IRA. As of 2022, single, head of household, and married filing separately taxpayers may contribute to one if their modified adjusted gross income (MAGI) is $129,000 or less. If their MAGI is $144,000 or more, they can’t contribute to a Roth IRA. 

There is a limit to how much one can contribute to a Roth IRA each year. As of 2022, the contribution limit is up to $6,000 per year. However, there are income-phase outs that can impact if and how much someone can contribute to a Roth IRA—the full amount, a reduced amount, or being ineligible to contribute.

Potential benefits and risks of Roth IRA withdrawal for a home purchase

Purchasing a home is a big investment and requires hefty financial resources. It may be the biggest purchase of one’s lifetime. While home prices and interest rates are rising, using Roth IRA funds to buy a home is one way to access more financial resources. Before doing so, however, it’s worth assessing the pros and cons. 

Potential benefits of using a Roth IRA to buy a house: 

  • Access to one’s own money to buy a home. Buying a home is costly. There is a down payment and closing costs to consider. To avoid paying for private mortgage insurance (PMI), one must have a down payment of 20% or more of the purchase price. The credit score of the buyer will have an impact on the interest rate on their mortgage. Using one’s own money may mean borrowing less for a down payment, and avoiding a PMI payment. A Roth IRA can be considered a type of savings account for this purpose if all other qualifications noted above are met. 
  • Avoid early withdrawal penalty and taxes. Since Roth IRA contributions are paid with after-tax dollars, one can take out funds for qualifying purchases like a house, without paying taxes on them. 

Potential risks of using a Roth IRA to buy a house: 

  • Missing out on potential investment gains. Withdrawing from a Roth IRA means taking money that was invested in the market. That may mean missing out on potential gains and reducing the total time in the market to build wealth. 
  • May pay the 10% early withdrawal penalty in certain cases. Taking out more than the $10,000 in earnings lifetime limit or tapping Roth funds before the account is five years old may result in a 10% early withdrawal penalty. 
  • Eligibility may limit ability to rebuild account balance. It may be easy to take out the funds, but rebuilding the Roth may be challenging. Investors who aren’t eligible to contribute to a Roth IRA because of their income may not be able to contribute money to replenish the account. Eligible investors must also observe the annual limit is $6,000 per year.

Alternatives to using a Roth IRA withdrawal for a house 

There are ways to find financing for a home purchase through other types of retirement accounts. A traditional IRA also allows investors to take out up to $10,000 for first-time home purchases. However, because contributions are pretax, an individual may end up paying income taxes on the distribution.

An employer-sponsored 401(k) plan, another type of retirement saving account, isn’t eligible for the homebuyer exception. But there are ways a 401(k) can be used to finance a home purchase. If one’s plan allows, a loan can be taken out from a 401(k). This allows individuals to borrow up to $50,000 from their employer-sponsored retirement account. A 401(k) loan typically has a repayment term of up to five years to pay back the loan in full. For this route, there is no early withdrawal penalty or income taxes.

Taking out an early hardship distribution, or emergency withdrawal of funds, from a 401(k) can mean paying taxes as well as the 10% penalty on the amount withdrawn.

To finance a home purchase, a mortgage can do much of the work without tapping retirement savings. It’s worth it to consider the total cost of the loan and what you can afford to pay back. Investors may assess the interest cost of a mortgage versus the interest earned on the investments through a Roth IRA. 

Using a Roth IRA withdrawal for a home purchase

To use a Roth withdrawal to buy a home, take the following steps:

  1. Review eligibility. To be eligible for a home-buying exception, the Roth IRA account must be at least five years old. If that’s not the case, wait it out. 
  2. Take the qualified distribution. Review contributions versus earnings in your Roth IRA and calculate the amount to take out. Remember, the maximum is $10,000; otherwise, taxes will be due. 
  3. Fill out appropriate paperwork. When taking a Roth IRA withdrawal for a home purchase, fill out the appropriate paperwork within the same tax year of the distribution. This includes IRS Form 5329 which is used to determine contributions and potential taxes on what may be considered an early withdrawal. For example, anything over $10,000 in earnings, or a distribution on a Roth IRA account that is less than five years old, may be considered an early withdrawal and subject to penalties. 
  4. Use Roth IRA funds to buy a home. Once you have Roth IRA funds, you have 120 days to pay costs associated with purchasing a home. This can be for closing costs, or anything is related to buying or building a home. 

The bottom line 

The answer to the question “Can you use your Roth IRA to buy a house?” is yes. A Roth IRA offers a way to use funds before retirement for large expenses like a home while avoiding an early withdrawal penalty. There are risks associated with this route, though, including potential lost gains that would otherwise compound over time. Consider speaking with a financial advisor who can help look at the big picture, so all risks and rewards are considered.

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