Using a ROTH IRA for a House Down Payment
Planning ahead is a measure of class.
When people hear of an IRA, the Individual Retirement Account, they automatically assume this money is for retirement only. This is one of the great misconceptions about the IRA. It’s helpful to know that an IRA can be used for many things. Although it should generally be used for retirement as it provides another vehicle for saving. No one knows how much Social Security will be left when many of us finally qualify and many aren’t also taking advantage of additional savings so it’s important that we all take advantage of the IRA.
For the sake of this post, I’ll cover the ROTH IRA as it is the account that many people will qualify for and will use. If you max out your ROTH IRA starting from when you graduate at the age of 22 until age 30, you would have $48,000 at the IRS current contribution limit of $6000 a year (for 2019). Of course, this doesn’t include any growth or compounding interest that your IRA account can grow into if invested properly. $48K is a significant amount of money at age 30. By around this age, you probably will be ready to settle down and find a place of your own. Hopefully at this time too, you’ve been maxing out other tax-advantaged retirement accounts and have additional savings for this house.
This is where the ROTH IRA can come in handy. I’m not sure if many people know this, but you can withdraw your ROTH contributions (not earnings) at any time without taxes or penalty because this money has already been taxed. This is why the ROTH IRA is one of the more lucrative savings vehicles out there and why the government keeps its maximum contributions limited at $6000 a year. You can also withdraw your earnings up to $10K as a first-time home buyer without any penalty as long as you’ve had the account for at least 5 + years. Any amount over $10K will be subject to taxes and penalties. This can significantly pad up your down payment and reduce your overall mortgage costs, lowering owed interest and monthly outflow of cash payments. You do have to be diligent about doing the math to make sure this nets out for you. It’s also equally important that if this will be your primary home to really consider the size and its impact on your wallet.
House buying can be a long-term goal for many people so it makes sense to invest your money instead of save it. With investing netting you greater than 2% interest rate, parking your money in an IRA that invests in the total stock market can be a terrific option for some long-term goals. Of course, if you are withdrawing money, it’s important to keep replenishing and investing into that IRA to ensure more savings in the future.
What We Did
My husband and I were able to take advantage of this option for our ROTH IRAs. While we had a good down payment already, we wanted to provide ourselves with a little more cushion. Knowing our other financial plans and what we’ve already been contributing to was also a big step in allowing us to make this decision. We continue to contribute automatically to our ROTH IRA. It is important that you review if this is the right decision for you. Pulling savings that has the potential to grow over time can be detrimental to your future retirement planning. So weigh the benefits carefully and slowly. While a house can be a good investment, it’s not always the best when you finally sit down to calculate the numbers.
We almost fell into the trap of buying a larger home, but thankfully, came back to our senses. I think that’s one thing we all have to be aware of to. Just because the bank says you can afford more and just because you can afford more, it doesn’t necessarily mean having more is better especially when it doesn’t fit the lifestyle that you desire.
To withdraw the funds, we just basically logged into our IRA accounts, in this case it was through Vanguard and selected the withdrawal option directly into our bank account. When we filed our taxes for the year, our accountant entered the amount as a ROTH IRA Distributions - Homebuyer’s Expenses which incurred no additional taxes for us.
So funding a ROTH IRA early on was a big help for us. It gave us a bit more financial leverage when it was finally time to buy a home. While the withdrawing from a ROTH IRA is not the only solution to ensuring you have a sizeable home down payment, it is a valid option should the need arise. Again, before you pull the trigger and withdraw the money, consider it’s impact on your other financial goals. Nonetheless, even if have no plans to buy a home yet, don’t forget to contribute and max out your ROTH IRA so that you can fully take advantage of this amazing savings vehicle.
Have you used an IRA withdrawal to fund a purchase? Let us know in the comments. What made you decide to withdraw from your IRA instead of other sources?