Individual retirement accounts, or IRAs, provide individuals with a tax-advantaged way to save for retirement without having to create a plan through an employer.
The tax-advantaged status of your IRA investments means facing certain rules for how and when you can tap into those funds. If you’re thinking of withdrawing from your traditional or Roth IRA to fund a down payment on a house, it’s important to understand these rules as well as the potential drawbacks of using your retirement savings for something other than retirement.
Let’s take a look at the ins and outs of withdrawing from the two types of IRAs for a home purchase and how making a withdrawal could affect your retirement plans.
Traditional IRA Withdrawal Rules
Traditional IRAs are funded with pretax or tax-deductible dollars, meaning you don’t pay taxes on the income you put into your IRA. When you retire and begin taking money out of the account, you’ll pay regular income tax on your withdrawals (also called distributions).
Basically, with a traditional IRA, you won’t pay taxes right now – you’ll pay them later.
Who Is Eligible For A Penalty-Free IRA Withdrawal?
To get the most out of your retirement savings, you won’t want to withdraw from your IRA before reaching retirement age.
If you take money out of your traditional IRA before you reach the age of 59 ½, not only will that money be counted as taxable income, but you’ll also typically be subject to an additional 10% penalty tax if you aren’t taking that money out for one of the situations the IRS allows exceptions for.
First-time home buyers are allowed an exception to this rule. The IRS defines a first-time home buyer as someone who hasn’t owned a home in the last 2 years. If you’re married, your spouse must meet this requirement as well.
Following the death or disability of the IRA owner, withdrawals can also be made without having to pay the 10% penalty. The same is true if you’re withdrawing money to pay for college tuition and other higher education-related costs, cover medical expenses or pay your health insurance premiums if you’re unemployed.
If you’re 59 ½ or older, you can withdraw penalty-free at any time. Once you reach age 72 (the law was recently changed from age 70 ½), you’ll have to take a required minimum distribution each year.
How Much Can I Withdraw?
If you’re a qualified first-time home buyer, you’ll be allowed to withdraw up to $10,000 from your IRA penalty-free.
This is a lifetime limit. For example, if you used $6,000 to fund a home purchase several years ago and you qualify for the first-time home buyer exemption again, you’ll only be able to withdraw $4,000 if you want to avoid the 10% penalty.
If you’re 59 ½ or older, you aren’t restricted on how much you can take out, but keep in mind that these distributions are considered taxable income.
What Are The Cons Of Borrowing From Your IRA For A Home Purchase?
While buying a house can also be an important part of building financial security and long-term wealth, it’s important to carefully consider the risk you’re taking and the potential growth you’ll be missing out on when you withdraw from your IRA.
Thanks to the power of compound interest, your money earns you more money when you keep it parked in a retirement account. When you take funds out of that account, you’re cutting into the amount you could end up with when it’s time to retire – potentially losing out on a significant amount of money.
Additionally, if you don’t qualify for the first-time home buyer exemption, you’ll have to pay the hefty 10% penalty on your withdrawal in addition to regular income tax.
If you’re considering this, it’s always a good idea to talk with a financial advisor who can evaluate your individual situation and guide you to a solution that fits your situation.
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Roth IRA Withdrawal Rules
Roth IRAs are funded using after-tax dollars. Because you’ve already paid taxes on the money, you won’t pay taxes when you withdraw it in retirement or take another type of qualified distribution.
With a Roth IRA, you pay taxes now rather than later.
How Much Can I Withdraw From My Roth IRA Without A Penalty?
One of the benefits of a Roth IRA is that, because you already paid taxes on that money, you can withdraw your contributions at any time and incur no taxes or penalties.
The key word here is contributions, or the money you initially put into the account. Because money in an IRA is invested in stocks, bonds, funds and other types of securities, the money will grow over time. That’s your earnings.
So, let’s say you have $25,000 in a Roth IRA. Of that money, suppose you’ve personally contributed $15,000 and the rest has come from the growth of your investments. You can typically access that initial $15,000 at any time, no strings attached. If you want to take out more than that, it may be subject to penalties or taxes if you don’t qualify for an exception to these rules.
If you’re 59 ½ or older and have had your Roth IRA for less than 5 years, you won’t incur a penalty, but you’ll have to pay taxes on your earnings. Once you’ve had the account for 5 years, you can begin withdrawing money without any taxes or restrictions.
Withdrawing From Your Roth IRA As A First-Time Home Buyer
If you’re under the age of 59 ½, you may want to be strategic about when you pull money from your Roth IRA’s earnings.
If you ’ve had the account for less than 5 years, you can withdraw earnings penalty-free for certain qualified reasons, including to fund a first-time home purchase (up to a $10,000 lifetime limit). You will, however, be taxed on this withdrawal.
If you’ve had the account for more than 5 years, you won’t be subject to taxes or penalties when withdrawing earnings for a first-time home purchase (up to $10,000). If you qualify for a different exception, such as using the money to pay for certain medical expenses, you likewise won’t be subject to taxes or penalties.
What Are The Drawbacks To Withdrawing IRA Funds?
As with a traditional IRA, withdrawing money from your Roth IRA before reaching retirement can jeopardize your future financial security and force you to pay penalties and taxes you otherwise wouldn’t pay.
Having a tax-free source of income in retirement can be incredibly beneficial. If you’re thinking of taking money from your Roth IRA to fund a home purchase, consider how much you might need that money later on.
IRA Withdrawal For Home Purchase FAQs
Let’s take a look at a few frequently asked questions about using an IRA withdrawal for a home purchase.
How do I report an IRA withdrawal?
When you make a withdrawal from your IRA, you’ll likely receive a 1099-R form from the financial institution managing your account. You’ll use this form to complete that year’s taxes.
Keep in mind that when you take a qualified distribution from your IRA to purchase a home, you must use those funds within 120 days to avoid taxes or penalties.
Is it a good idea to withdraw from my IRA for a home purchase?
It depends. For example, if you’re a first-time home buyer and have many years left to build your retirement fund, it may not make as big of a difference to withdraw from your IRA. But if you’re strapped for cash and know that withdrawing from your IRA could be risky when you retire, it may not be wise to withdraw.
We recommend consulting a financial advisor on the best decision for you regarding IRA withdrawal.
What are some alternatives to a withdrawal IRA as a first-time home buyer?
If tapping into your IRA isn’t the route you want to take for coming up with a down payment, some alternatives are worth keeping in mind. These include down payment assistance programs, a gift letter from a family member or making a smaller down payment if your loan program and lender allow for it.
The Bottom Line: Consider Your Future Finances Before Using IRA Funds For A Home Purchase
Everyone’s financial situation is different. The question you’ll need to answer is: What makes the most sense for your money – using it to build equity in a house or growing your retirement fund?
Keep in mind that first-time home buyer programs and low down payment options are available for various mortgages. You won’t easily find loans for retirement, however. While it can make sense in some situations to use money from an IRA to help fund a down payment on a home, be sure you’re considering your entire, long-term financial picture before making any decisions.
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Miranda Crace
Miranda Crace is a Staff Writer for Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate and personal loans for over 10 years. Miranda is dedicated to advancing financial literacy and empowering individuals to achieve their financial and homeownership goals. She graduated from Wayne State University, where she studied PR writing, film production and film editing. In her spare time, Miranda enjoys traveling, actively engages in the entrepreneurial community, and savors a perfectly brewed cup of coffee.
