using roth ira buying first house

First Time Home Buyer

Rules for Using a Roth IRA for Buying Your First House

Investment retirement accounts (IRAs) are intended to help you save for retirement. Typically, you’re not supposed to withdraw any funds from them before you turn 59½. To enforce that, the IRS charges a 10% penalty along with income taxes. However, one exception to this rule is when you use your IRA funds for buying your first house. 

Here are a few things you should know before you take out your IRA to buy a new home.

Do I Qualify for an IRA Exemption?

To use your IRA to buy a house, you have to be a first-time homebuyer. The IRS considers you a first-time buyer if you haven’t owned a home during the last two years.

You can also tap into your IRA and qualify for the exemption if you use the money to help an eligible child, grandchild, or parent buy a home – even if you’re currently a homeowner.

Traditional IRA Exemption

If you qualify as a first-time homeowner, you can take out up to $10,000 from your traditional IRA and use it to buy a home. You won’t be charged the 10% early withdrawal penalty on the money, but you’ll still owe income tax on any amount you withdraw. That $10,000 limit lasts for life, which means you can’t use the first-time homebuyer provision again.

Roth IRA Exemption

The rules for a Roth IRA are a little different. Qualifying depends on how long you’ve had your account. You can use the contributions you’ve already made to your Roth IRA without paying taxes or fees at any time, for any reason – that’s because you already paid taxes on your contributions.

After you spend your contributions, you can withdraw up to $10,000 of earnings without paying the penalty – as long as it’s for buying your first house.

If it’s been less than five years since you started contributing to your Roth IRA, you’ll have to pay income tax on the earnings. However, this rule doesn’t apply to converted funds. If you’ve had the Roth IRA for five years or more, your withdrawn earnings are tax- and penalty-free.

Should Your Buy Your First Home Using Your Roth IRA?

While you can withdraw funds from your Roth IRA for a home purchase, the next question is – should you do it?

Unless you opened the IRA specifically for a home purchase, you should think about getting your funds from another source. If you clean out your investments today, it can significantly set back your retirement savings.

There’s only so much that you can put into an IRA each year. For 2020, that amount is $6,000 if you’re under 50, or $7,000 if you’re 50 or older. You can’t pay back the funds once you take them from your IRA. After you withdraw the money, it’s gone, and you’ll lose out on years of compounding interest.

There may be better options for you, like taking out a personal loan or tapping into your 401(k).

Conclusion: Smart Home Buying Pays Off

If you need to use your IRA to fund your home purchase because you have no other options, reconsider your home purchase timing. It probably makes more financial sense to wait until you’ve saved the entire down payment while leaving your retirement savings intact. Or try exploring other options like first time home buyers assistance programs and grants. 

To learn more about buying your first house with a Roth IRA or any other source, contact us today!