Ways To Fund The Purchase Of A Home
Good Monday Morning!
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 If you withdraw money from the account before age 59 1/2, you will typically have to pay a 10% penalty on the amount withdrawn.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. While you may be eligible to withdraw, there could be long-term implications. "It is important to remember that dragging money out of your retirement account means you’ll have less money available for your golden years,” says Dan Belcher, founder and CEO at Mortgage Relief in Oklahoma City.
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.
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.
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. “As long as the funds are being used to buy a primary residence, the IRS permits first-time homebuyers to withdraw up to $10,000 from their traditional IRA without paying the customary 10% early withdrawal penalty,” Belcher says. This $10,000 exception can be applied individually, meaning a married couple could each take $10,000 from their accounts, totaling $20,000 for the down payment.
In addition to purchasing your own home, you may qualify to help others buy their first house. If you have an IRA, you could withdraw to help a child, grandchild or parent provided you meet the requirements. “The traditional IRA exemption allows for a withdrawal of up to $10,000 penalty-free, as long as the funds are used to purchase, build or rebuild a home,” says Matthew Martinez, a real estate broker and CEO at Diamond Real Estate Group in the San Francisco Bay area. “It’s crucial to know that the $10,000 is a lifetime limit, and once used, you can’t use the first-time homebuyer provision again, even with a different IRA.”
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. "If you have a Roth IRA, you can withdraw a sum equal to the contributions you’ve made tax and penalty-free at any time,” Martinez says. “After you’ve exhausted your contributions, you can withdraw up to $10,000 of the account’s earnings or money converted from another account without paying a 10% penalty for a first-time home purchase.”
If you have contributed to a Roth IRA for less than five years, you’ll owe income tax on any earnings you withdraw. For Roth IRAs that are more than five years old, you won’t have to pay taxes on the earnings. Taking out funds before retirement could impact the long-term potential of the balance to grow.
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. "If you prefer not to use your IRA, borrowing 50% of your 401(k) balance, up to a maximum of $50,000, could be another alternative worth exploring,” Martinez says. A 401(k) loan typically doesn’t have taxes or penalties attached to it. However, you’ll be charged interest as you make loan repayments.
Looking at the balances in retirement accounts and current salary could help the decision-making process. “Although using IRA assets as a source of financing for a down payment or purchase price is a possibility, it isn’t always the ideal choice,” says Sara Sharp, founder and partner at SK&S Law Group in Denver. “Homebuyers should think about any early withdrawal penalties and any tax repercussions before taking money out of their IRA."
If you consider your long-term savings balances to be substantial, withdrawing may not have a significant impact on your overall financial picture. For account holders who feel they haven’t saved much, it could be time to consider another option like a mortgage. You might decide to apply for a regular home loan to help cover the costs of the purchase.
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