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Buying your first home is a memorable experience.  It can be hard, however, for young people to save up for a down payment, especially in today’s market when housing values have increased.

It’s not surprising, then, that many people consider whether they should use their retirement account to help with the down payment.

Is it wise?  Well, it’s not a bad idea.  In fact, I used money from my IRA to help with the purchase of my first home!

Is it ideal?  It’s probably not ideal, as taking money out of retirement accounts can be costly compared to other types of accounts. 

If you are considering using retirement funds to help with your home purchase, here are some considerations to help you with your decision.

First-time Homebuyers Can Withdraw Up To $10,000 Penalty-free

Retirement accounts have special tax advantages.  As a result, the IRS doesn’t want you to withdraw these funds until retirement age—typically 59 ½.

For the most part, any money withdrawn from a pre-tax retirement account (like a Traditional IRA) will always be counted as taxable income in the year you withdraw it—even if you are retirement age.

But if you withdraw it prior to age 59 ½, it’s considered an early withdrawal.  This means an additional 10% early withdrawal penalty.  You can see how accessing these funds can get expensive.  Combined, income tax and penalties could cost you over 30%.

But the IRS allows first-time homebuyers to withdraw up to $10,000 penalty-free.  Yes, you will still pay income tax, but at least you can avoid the 10% early withdrawal penalty.  If you are married and you each have your own IRA’s, you can each potentially withdraw $10,000 (for a total of $20,000 on the purchase of your home.

It’s important to note that the IRS considers you (and your spouse, if married) a “first-time homebuyer” if you haven’t owned a principal residence in the past two years.  Also, you can only use this privilege once in your lifetime.

Roth IRA Contributions Can Be Accessed Tax-Free

Unlike Traditional IRA’s, Roth IRA’s are funded with after-tax contributions.  As a result, the money you’ve contributed is allowed to be withdrawn at any time tax-free.  Any earnings that you withdraw are subject to income tax and the early withdrawal penalty if you are younger than 59 ½.

Some 401(k)’s Offer Tax-Free Loans

Another retirement account that can be accessed for a down payment is your 401(k).  However, 401(k)’s differ from IRA’s in that they offer loans

A 401(k) loan isn’t a withdrawal.  As such, it’s not counted as income for tax purposes, nor is it penalized.  Not all 401(k) plans offer loans, and the maximum loan is capped at 50% of your vested account balance or $50,000 (whichever is less).

The repayment period for your 401(k) loan is 5 years, though you might be able to choose a longer repayment period when using the funds to purchase a home.  If you leave the employer with an outstanding loan balance, be prepared to pay off the loan or have the balance counted as taxable income.

Though a small loan for 5 years or less shouldn’t handicap your future retirement, taking large loans during strong periods of high market returns can mean sacrificing the benefit of compounding growth.

Inherited IRA’s Have No Early Withdrawal Penalty

If you’ve inherited a retirement account from a loved one, you likely have an “Inherited IRA” or “Beneficiary IRA”.  While the rules for inherited IRA’s have changed in recent years, the IRS expects you to make withdrawals.  In fact, if you inherited an IRA after January 1, 2020, you have 10 years to withdraw the full balance.

These rules make inherited IRA’s great accounts to access for a down payment.  Since you must withdraw the balance eventually, why not use it for your house?

Yes, withdrawals from an Inherited Traditional IRA will still be subject to income tax.  But there are no early withdrawal penalties!

The Bottom Line

A retirement account shouldn’t be the first place you look to when needing funds for a down payment.  It can be expensive, with taxes and penalties that could cost you over 30%.  Not to mention the purpose of the account in the first place was to compound and grow your funds for retirement.

However, the fact of the matter is people have balances in retirement accounts, and they are wondering how they can access these funds to make home ownership a reality.  There are ways to balance these seemingly competing goals, namely: 

  • Be smart about how much you withdraw.  Dollar amounts do matter.  A $10,000 withdrawal from your IRA affects your future retirement much less than $100,000.
  • Consider options like the IRS first-time homebuyer exemption and 401(k) loans.
  • Make a plan for replenishing retirement savings after you’ve purchased the house.

Home ownership can be affordable.  Besides considering all your resources, it’s smart to work with a wise mortgage loan advisor who will educate you on the home buying process.  That’s why Stewardship offers the FREE “Home Buying Game Plan”.  No matter if you are 3 months or 3 years away from purchasing a home, the Home Buying Game Plan will help put you in the best situation possible to purchase a home.

If you are interested in learning more about our free Home Buying Game Plan, check out this web page.