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First Time Home Buying: Using IRA to Buy a Home

Written by Nickel - 31 Comments

It’s fairly well know that if you’re not at least 59-1/2 years old, you can’t generally take a distribution from your traditional or Roth IRA (or SEP-IRA, for that matter) without incurring a 10% penalty (note that Roth IRA contributions can be withdrawn at any time, for any reason, without incurring a penalty). There are, however, a number of exceptions to this rule, and one of them has to do with buying a home.

Ever since the 1997 Taxpayer Relief Act went into effect, people have been able to withdraw funds to pay up to $10,000 in first-time homebuyer expenses without incurring any penalties. Such withdrawals are, however, potentially subject to taxes. Interestingly, the IRS has a somewhat obtuse definition of “first-time homebuyers.” As it turns out, anyone that hasn’t owned a home for two years is considered a first-time buyer. And guess what? You don’t even have to be the one buying the house to qualify… The first-time homebuyer can be the owner of the IRA, the IRA owner’s spouse, or any of his or her (or his or her spouse’s) direct descendants (e.g., children or grandchildren).

Other major restrictions include a 120 day time limit for buying the house from the day after the withdrawal is made, and the house must be purchased for use as the buyer’s principal residence. Just keep in mind that the $10,000 limit is a lifetime limit – if you do this now, you won’t do it again in the future.

So.. While you can use IRA funds to aid in the acquisition of a house, does that mean that you should? In our case, my wife and I raided our Roth IRAs for cash to help with buying our first house. In fact, we knew that this was a possibility when we were funding our IRAs in the years leading up to our home purchase. Nonetheless, we figured it would be a good idea to max out our Roth contributions on the off chance we could pull off the home purchase without needing those funds. Alas, we couldn’t, so we had to pull some of that money back out.

In retrospect, I have very mixed feeling about this. On the one hand, it allowed us to buy our house without having to carry private mortgage insurance (though we still ended up going with an 80/10/10 mortgage). On the other hand, IRA contributions are limited on an annual basis. Thus, when we pulled money out, we were limited in our ability to put it back in. We’re now in the situation where we can’t contribute to our Roth IRAs because we exceed the income limits. I’d love to have more money in our Roth IRAs but, for the time being, that’s not in the cards.

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Published on August 27th, 2007
Modified on June 23rd, 2011 - 31 Comments
Filed under: Mortgages, Real Estate, Saving & Investing, Taxes

About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

31 Responses to “First Time Home Buying: Using IRA to Buy a Home”

1
razmaspaz Says:
August 27th, 2007 at 2:28 pm
My situation is almost an exact mirror of yours. I’m sure I’m approaching those pesky income limits as well. I have a feeling in fact that I am about to learn the hard way about all those retirement account limits. I am happy I used the IRA for the down payment. If I had to sell my house for some reason right now, I think I would be upside down on the house. The only thing that will keep me from owing the bank money in that case is the larger down payment.
2
Mike Says:
August 27th, 2007 at 3:49 pm
I’m firmly against pulling money out of a Roth IRA for a down payment. Everything in that account is tax free forever*. That’s very powerful, especially with 30-40 years of compound interest working in your favor.

[*] – Or until the law changes
3
MoneyNing Says:
August 27th, 2007 at 5:17 pm
It is generally believed that it is a bad idea because taking money out of your retirement funds will greatly slow down the growth of your retirement nest egg.
4
Aaron Says:
August 28th, 2007 at 12:42 am
I have to agree with Mike on this one. Taking that money out of the Roth IRA has to be the very last resort because compounding makes the gains in a Roth IRA extremely impressive over time.
5
Phil Says:
August 28th, 2007 at 10:47 am
Given the time value of money, early contributions to an IRA are worth more than contributions made later. Accordingly, I tend to agree with Mike and Aaron.

In my opinion, one of the biggest mistakes a first-time homebuyer can make is to deplete his/her savings to afford a larger down payment. 5% is often all that’s required to capture excellent rates on your first mortgage. By holding back some funds, you safeguard yourself to some extent against losing the home if you suffer a major financial setback.
6
Debbie Says:
August 28th, 2007 at 11:58 am
On the other hand, if knowing you can pull the money out to help with the down payment if you need to gets you to invest more than you otherwise would have, then that’s a very good thing. If it turns out you’ve put too much in, it’s okay because you can get it back out. And having to pull it out will make you sad enough that you’ll try really hard not to.

I think nickel’s strategy was brilliant. I wouldn’t be surprised if there were still more in that IRA than there would have been if nickel had been conservative and kept more money out to use for a down payment.

Maybe waiting longer to buy a house would have been a good strategy, too, but it’s harder to tell about those things, especially if your monthly rental housing expenses are similar to your monthly buying housing expenses. Now every year is one step closer to the end of the mortgage.

Disclosure: I bought my house pretty much the second I possibly could. This turned out not to be a mistake for me because my income has not risen as fast as housing prices have. (My income has doubled, housing prices have tripled.) Normal people who don’t have trouble keeping up with first-year-teacher salaries should probably consider waiting.
7
akb Says:
August 29th, 2007 at 12:15 pm
Correct me if I’m wrong, but with a Roth IRA you can withdraw your contributions at anytime, its the ability to take out the $10,000 in earnings without penalty or tax which is the benefit.

Personally, I think if you can meet your retirement saving goals with your 401k plan, it makes a lot of sense for prospective home buyers to take advantage of the ability to grow their down payment tax free.
8
Walt Padabney Says:
August 29th, 2007 at 12:35 pm
Just because you can do it doesn’t mean you should.. You have to compare the after tax cost of borrowing funds vs. the Tax Free growth of invested funds. For example, If you have to borrow at 7% and are in a 30% state and federal effective rate, your tax free equivalent return needs to only be 4.9%… So keeping the Roth funds makes the most sence if you invest well enough to earn more than CD rates.
9
retirehappy Says:
August 29th, 2007 at 5:14 pm
Seems like a bad idea, once it goes it you should keep it in until retirement because once it comes out your balance isn’t growing as fast.
10
Robert Says:
August 29th, 2007 at 5:37 pm
I agree with just about everyone else. Even though you will (hopefully) get some appreciation out of your house, it is highly likely is won’t be more than the gains you would get from keeping your IRA funds together. The exception to this is if you keep your IRA as a small interest account and who does that?

One way this _could_ work would be if you are getting a great price on the house and thus could take equity back out to put back into your IRA. However you would then be paying the mortgage interest on that. The interesting thing here is that interest could be tax deductible.
11
nickel Says:
August 29th, 2007 at 5:41 pm
I agree that unnecessarily raiding your IRA is a bad idea. In our case, however, the alternative would’ve been to not fully fund the IRAs in the first place while we were saving for a down payment – or to not buy a house. Our hope was that we could stuff the IRAs full of money and then get away with not raiding them if we could scrape together more money than we initially projected. We couldn’t, so we ended up taking a portion of the money back out, but we were no worse off than had we saved for the down payment straightaway.

In the end, we came out way ahead on the house, so it worked out for us.
12
Phil Says:
August 29th, 2007 at 7:40 pm
Nickel, I see how your strategy worked and think it was probably the best move you could have made. I just worry about folks putting every dime of liquidity into equity; loss of income then puts those folks in dire straits.
13
EMF Says:
September 2nd, 2007 at 9:44 pm
If you’re contemplating doing this, a Roth IRA would be the way to go. If done using a traditional IRA then you get hit with all the taxes in one year and could very well end up in a higher bracket.

And if the choice is between saving for a down payment in a Roth Vs saving for the down payment in a taxable account, the choice of a Roth is a no-brainer.
14
Steve Says:
December 5th, 2007 at 2:13 pm
I have questions and comments about what’s best to do in my situation.

I have a 70 year-old mother who has $100K in an IRA account… She has rented for 26 years despite numerous attempts to get her to purchase a home… she retired in July of 2007 and now wants to buy a house with her tiny next egg. We have found her a place for 75K…. QUESTION: Can she and/or should she buy the house cash with the IRA and avoid any taxes… it appears from the comments that she would only save taxes on the initial $10,000.00… She is on a limited income and is drawing SS and from an annuity that runs out in 5 years… Her current rent is 750.00 a month. My concern about financing the house is that 1.) she will be paying interest on the 15 year note. 2.) in 5 years when she needs money she will not be able to borrow against the house because of her limited income.

Is there any advice that anyone can offer based on these circumstances?

We have discussed some of this with “Financial Planners” and they all recommend continuing to rent and let them try and grow the 100K in 5 years to $145K – 175K a major risk in my opinion and not one that addresses her rent situation which will be closer to 900.00 over the next 5 years.

Mathematically speaking I see most of the gains in the stock market (if it gains at all) being washed out by interest or increases she will incur in other areas of her life… like rent, cost of living increases, etc. Point being: owning a home seems to me to be the best investment under the circumstances… but how to minimize her tax burden is what I think we need help with.
15
Chris in Sacramento Says:
July 28th, 2008 at 12:57 pm
Seems to me that it might be worth pulling 10,000 out of my Roth IRA to avoid paying $200/month in PMI. But there’s definitely a long-term price to be paid for not letting the money compound.
16
Tim Says:
October 22nd, 2008 at 10:55 pm
What happens in this case ( as stated in the second paragraph). Approaching 70 years old, can I sell the house out of the Roth to my wife?
17
keviin Says:
February 12th, 2009 at 6:08 pm
We are considering doing something similar to what you described. I have a couple of questions. We are considering purchasing a house in february of 2010. Should we fully fund both our IRAs this year(2009) to get a tax break, and then withdraw the money before we close? Is the withdrawal subject to taxes?
18
Bryan Says:
October 19th, 2009 at 8:32 pm
80/10/10 loans are still around? Who offers these?
19
Retiree Says:
October 29th, 2009 at 12:16 pm
What if you fund a retirement account for the purchase of saving tax-deferred income as a down payment? With mutual funds, you get taxed. Did I just find a loophole?
20
Mark Says:
March 27th, 2010 at 11:43 am
My wife and I have decided to liquidate the IRA to buy a house for cash and not have a mortgage. We’re around 54 years old and willing to take the taxe hit. Is this a horrible idea?
21
Larry Says:
April 9th, 2010 at 2:26 pm
My wife and I are considering doing the same thing. If you find credible advice, please share. Good luck!!
22
Deanna Says:
June 16th, 2010 at 11:02 pm
Personal opinion re: the 70 year old – I suspect that the “financial planners” won’t be able to come up with any investments that SAFELY get 9% annual return on the 100K. What they DO get is a percentage of your mother’s money when they sell her investment “products”, so that money has to earn even more than 9% for her to break even on the invest-vs-rent scenario. To be fair, there are cost to owning a house (taxes, repairs), but the house can also be expected to appreciate over time. If your mother is disciplined, you could have her buy the house, but set up to have $750/month automatically deposited into a special “house expense” bank account (money has a way of spending itself if it is sitting in your “regular” acct), and let the next egg build from the difference between what it costs to own her own home and what she would have otherwise spent in rent. There are I believe some other advantages — should she become unable to care for herself and have to rely on the government for extended care they will make her spend all her cash before they’ll help, but if I remember correctly won’t take her home until after her death. Doesn’t help the estate, but does help her have somewhere to live if she is in and out of care many years down the line.
23
Mel Wheeler Says:
September 29th, 2010 at 12:47 pm
I am 38 years old and have a new IRA I just established. The family across the street is short selling their home. It is my understanding after speaking with a few companies, http://www.selfdirectediragroup.com and pensco.com I can purchase the home without taking a distribution tax and penalty free. Is anyone else aware of this or completed a similar transaction?
24
Andrew Says:
October 16th, 2010 at 1:47 pm
I think withdrawing Roth IRA money for a down payment could be a good idea. If you otherwise would be saving the same down payment money in a taxable account then it could be ok. If you have enough to do both; save for your down payment and fully fund retirement accounts then great, do it! The tax advantages of a Roth have been somewhat oversold. Roth’s are just a good tool to add to your total asset toolbox allowing you to determine when to pull out taxable vs tax-free income. When do do the math paying the tax now(say 28%) and then investing the remainder vs investing the full amount and paying the same tax rate(again 28%)the results are identical. Don’t believe it? Do the math with a compound interest calculator, you’ll have exactly the same assets available to spend. So the main advantage of your Roth over your 401K maybe asset choice. If you change jobs then rollover your last 401 K into a traditional IRA and your have full control of asset allocation. So bottom line be a disciplined saver and a smart investor in all assets including your house then you’ll win long-term
25
nasir Says:
February 2nd, 2011 at 2:01 pm
i withdraw ira, to buy home, but i am ending up not buying, can i put money back in ira and not pay penelties ?
26
Robin Says:
February 18th, 2011 at 1:30 am
I am considering taking money out of a traditional IRA account as a down payment on a foreclosed home that is in good condition. If I take it out at 59 rather than 59 and 1/2, will I still pay the 10 % penalty? If I wait until 59 1/2, I will only pay the taxes from the money removed? Would I be better off to take out less than ten thousand? Of course, if I wait, the house may be sold.
27
Tony Says:
April 18th, 2011 at 2:00 am
Thank you for the helpful information.
We are hoping you can help us with a way to borrow or withdraw from one of my Anuity funds with the least amount of penalties or tax hits? (Newengland Carpenters Annuity Fund)
I am 30 years old & my wife and I just purchased our first home.
I have a 401 that I am not tapping into, but I also have an anuity fund with the New England Carpenters Annuity Fund from 11 years ago when I worked in the union in Massachusetts. It was only for a short time so there is only $4100.00 & I can no longer contribute as I am not a member of the Union. We currently live in Florida & I just purchased my 1st home and would like to borrow or withdraw.
We closed on home 3 days ago, but when I called the Anuity fund they told me that my closing was to close, & not enough time to do paper work and usually 2 week, 1 month approval span. Anyway, she said I may be able to borrow if I need any improvements done on the home. I was not sure what to do. I told them I would call them back. Anyway, I borrowed $3500.00 from my father to put towards the down payment and I told him I was going to pay him back after I withdraw or borrow from my annuity. Question;
Because I closed on my home 3 days ago, is there still a way I can withdraw or birrow from my annuity as a first time home buyer?
Thank you for your time? Tony
28
Dean Says:
June 12th, 2011 at 4:33 pm
I think I really screwed up. We own a home that became to big for us. Couldn’t sell it, so we will be renting it out. Found a nice condo for $150th. Couldn’t get a loan, so pulled $150th out of our IRA I am old enough, 64, but never took in consideration that we will have to pay regular income tax on the $150,000 that we pulled out. Any way around this. Oh, please, tell me there is.
29
james cranfill Says:
August 12th, 2011 at 5:56 pm
I am 75 years old, not contributing to IRA, but making RMD. Can I withdraw all of the traditional IRA and buy a home for myself ?
30
Theresa Says:
July 27th, 2012 at 1:29 pm
I didn’t leave anything for you to put on my face book page. How did you get access to use my name and picture, making people think I put it there myself. There is a thing a web security, I will report you, if I see this happen again.
31
stephanie Says:
April 16th, 2013 at 5:59 pm
Thank you for any other great article. Where else may anybody get that type of info in such an
ideal means of writing? I’ve a presentation subsequent week, and I am on the search for such information.

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