Using IRA Funds to Buy a House - Good or Bad Idea?
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or Roth IRA (or SEP-IRA, for that matter) without incurring a 10% penalty (note that Roth IRA contributions can be withdrawn at any time, for any reason, without incurring a penalty).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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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.
Comment by razmaspaz — Aug 27th 2007 @ 2:28 pmI’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
Comment by Mike — Aug 27th 2007 @ 3:49 pmIt 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.
Comment by MoneyNing — Aug 27th 2007 @ 5:17 pmI 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.
Comment by Aaron — Aug 28th 2007 @ 12:42 amGiven 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.
Comment by Phil — Aug 28th 2007 @ 10:47 amOn 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.
Comment by Debbie — Aug 28th 2007 @ 11:58 amCorrect 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.
Comment by akb — Aug 29th 2007 @ 12:15 pmJust 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.
Comment by Walt Padabney — Aug 29th 2007 @ 12:35 pmSeems 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.
Comment by retirehappy — Aug 29th 2007 @ 5:14 pmI 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.
Comment by Robert — Aug 29th 2007 @ 5:37 pmI 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.
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.
Comment by Phil — Aug 29th 2007 @ 7:40 pmIf 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.
Comment by EMF — Sep 2nd 2007 @ 9:44 pmI 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.
Comment by Steve — Dec 5th 2007 @ 2:13 pm