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or Roth IRA (or SEP-IRA, for that matter) without incurring a 10% penalty (note that Roth IRA contributions can be withdrawn at any time, for any reason, without incurring a penalty).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.