With mortgage interest rates at almost historic lows, some of you may be pondering using your Roth IRA fund to help buy a house. Let’s take a look to see if you are even allowed to do this, and if so, whether it is a good idea.
Can I Use My Roth to Buy a Home?
The bottom line is yes, you can use funds in a Roth IRA to purchase a home. However, there are two different ways of going about it. Which method applies to you depends on your homebuying situation.
Special First-Time Homebuyer Clause
Roth IRA rules state that a first time homebuyer can withdraw funds from a Roth IRA under the following conditions:
- The account has been open for five years.
- You withdraw $10,000 or less to purchase a home.
- The funds are used directly toward home acquisition (down payment, closing costs, etc.).
If the above criteria are met you can withdraw every last cent of your Roth IRA, up to $10,000, from the account. The $10,000 limit is a lifetime limit, by the way. If the rules are met, the withdrawal will count as a qualified distribution and you will avoid paying income tax and early withdrawal fees.
Who Is a First-Time Homebuyer?
The good news: You don’t have to have never bought a home to qualify for this benefit. You just have to have not owned a home during the two-year period before buying this new home.
By the way: If you’re married, you can’t use this provision unless your spouse also qualifies as a first-time homebuyer. If he or she does (and owns a Roth IRA and has not already used the $10,000 lifetime limit), you would qualify to borrow $10,000 from each of your Roth IRAs, for a total of $20,000.
Withdraw Contributions at Any Time
What if you aren’t a first time homebuyer? What if you want to withdraw more than $10,000? You can still withdraw.
One of the major perks of using a Roth IRA is that you’ve already paid income tax on your contributions. Your account grows until retirement, and you never pay another cent of income tax on your nest egg. Likewise, you don’t pay any income taxes by withdrawing your contributions.
You can withdraw all of your contributions at any time without penalty or tax. (Your earnings have to stay in the Roth IRA.) So if you have socked away a lot of money over the past several years into a Roth you could pull those funds out to aid in your home purchase.
“However, in this low (although rising) interest rate environment, your investments might be earning 8 percent or more and your mortgage will probably be below 5 percent—which means you wouldn’t want to sell your investments when they are earning more interest than you pay on your debt,” says Herbert Kyles, a financial planner with AspenCross Wealth Management in Westborough, Mass.
Is Using a Roth for a Home Purchase Wise?
Now that you know you can withdraw funds from your Roth IRA for a home purchase, the next question is should you?
Do You Have Other Funding Options?
Unless you specifically opened up the Roth IRA to set money aside for your home purchase, you might want to consider other funding options. Wiping out your initial investments today will set back your retirement savings by many years. You end up losing out on the growth in the account. There is less time for compound interest to work in your favor, and your nest egg ends up being smaller in retirement.
You also have only a limited amount that you can save in an IRA each year ($5,500 or $6,500 if you’re 50 or over). You can’t just repay everything you took from your Roth if you get funds later.
“The reason you’re putting your money into a Roth IRA is to fund your retirement. IRA stands for ‘individual retirement account.’ Taking that money away from that account that is purposely created for retirement savings can hurt you down the road,” says John Daly, CFP®, president, Daly Investment Management, LLC, Mount Prospect, Ill.
“The compounding tax-free growth lost due to your use of the funds for a home purchase can be significant, especially if you’re many years from retirement. This move could cost you dearly in future wealth building. Tread carefully!” says John Madison, CPA, financial coach, 60 Minute Finance, Ashland, Va.
If you are having to tap an IRA to fund your home purchase because you have no other options, you need to reconsider. A home purchase is a major decision (as is gutting your retirement). You need to be setting aside money monthly to save up for a down payment. If you are so low on cash that you need to tap your retirement savings, maybe it would be better to wait until you’re able to come up with the down payment without hitting up your Roth.
“If you have a goal of making a home purchase in the next few years, you’re better off setting aside cash in a high-yield savings account and designating it for that purpose,” says Levi Sanchez, co-founder and financial planner, Millennial Wealth, Seattle, Wash.
Investment Performance Expectations
The only reason you might consider gutting your Roth IRA to buy a home would be if you were extremely pessimistic about the future of investing in the stock market.
You would have to be deeply pessimistic about the future of the market if you feel you’re getting a better return by avoiding taking out a higher mortgage (minus potential mortgage interest tax deductions) than by investing. Many people also look to reduce (or avoid) a mortgage to improve their monthly cash flow.