Buying a home can be a big step towards securing your financial future, but saving for the down payment can be very time-consuming.
However, if you already have money in your retirement accounts, you might be able to use it to speed up the process. We’ll discuss which accounts don’t penalize you when you use the money to buy a first home as well as strategies for saving on penalties and taxes.
Using Your IRA for a Home Down Payment
The IRS discourages you from withdrawing money from your retirement accounts early by charging a 10% penalty on withdrawals before you turn 59 1/2.
Among the various kinds of retirement accounts, pulling money from a Roth IRA will cost you the least in taxes and penalties. This is because you can withdraw contributions at any time without penalty or tax. In addition, after you’ve held the account for five years, you can withdraw up to $10,000 in earnings without penalty or tax for the purchase, repair, or remodel of a first home. In other words, if you withdraw all of your contributions, you can still withdraw another $10,000 and not pay the 10% penalty or taxes on any of it.
There is one caveat however: you only have 120 days to spend withdrawn earnings or you may be liable for paying the penalty. Also, for your convenience, your financial services firm will automatically prioritize the withdrawal of all of your contributions from a Roth IRA before any earnings.
The next best choice is a traditional IRA. You’re still able to withdraw up to $10,000 for the purchase, repair, or remodel of a first home without paying a penalty, but you’ll have to pay regular income tax on the entire amount. SIMPLE and SEP IRAsfollow the same rules.
With a traditional IRA, you must also use the money within 120 days for the purchase of a home or you’ll get hit with the 10% penalty. Alternatively, you can withdraw up to $10,000 penalty-free for the purchase of a home for your spouse, parents, children, or grandchildren.
Just like with a Roth IRA, your spouse can also withdraw $10,000 from his or her traditional IRA, so you can collectively obtain $20,000 penalty-free for a down payment if you’re married. The $10,000 limit is a lifetime limit for each individual.