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How to Use a Roth IRA for a Down Payment Without the Tax Penalty

Sometimes it seems like becoming a homeowner is an impossible journey. There are many blockades, but one of the largest is the need for a down payment.

While there are options for purchasing a home without a down payment, bringing something, anything, to the lender’s office will help your chances of approval. With a large down payment, you also have a better chance for lower monthly bills, lower interest rates, and better terms on your loan.

But saving for a down payment is not easy when you have rent, car loans, student debt, and the rising cost of living. How can you possibly raise the thousands of dollars needed for a down payment?

Roth IRAs, which are meant to be retirement-savings accounts, can actually be used as a down payment, according to the rules of the IRS. That’s right, if you are struggling to save for a down payment but have cash in a Roth IRA, there is a little-known rule that you could use to pull a down payment from your retirement funds, all without the significant tax penalty that usually comes with an early withdrawal.

Using a Roth IRA for a Down Payment? Yes, It is Possible!

Roth IRAs are simply retirement accounts that have tax benefits that allow for greater savings, acting as a shield from taxes as the account grows. Normally, if you withdraw from an IRA before the age of 59.5, you would pay a 10% tax penalty. However, there are certain exceptions that allow you to withdraw money without the massive tax hit. Being a first-time homebuyer just happens to be one of those situations!

While it is limited, this rule allows for the withdrawal of up to $10,000. You can always withdraw more, but anything over $10,000 will be subject to a tax penalty. For example, if you withdraw $20,000, the first $10,000 will be free of a tax burden, while the remaining $10,000 will be subject to a 10% tax penalty equalling $1,000.

Using Roth IRA for a Down Payment: A Brief Look at the Rules

To use Roth IRA funds for a down payment, the account will first need to be at least five years old. Next, you will have to be a “first-time homebuyer,” which is actually defined by the IRS as not having purchased a home in the past two years. If you have purchased a residential home in the past two years, you will not be eligible to take out Roth IRA money without a tax penalty. Also, if your spouse has purchased a home in the same timeframe, neither of you are eligible. So if you are a “first-time buyer,” but your husband or wife has bought a home in the past 24 months, you can’t use the benefit.

There is a limit on how you can use the funds as well. The funds have to be use for the costs associated with purchasing a home, which can include down payments, closing costs, and financing payments. You can use the funds for your own personal home purchase, or you can use them to help a family member, including a child, grandchild, or parent. You can also use the extracted money to assist a spouse who is purchasing a home, even if you won’t be listed as an owner.

Couple discussing retirement accounts with expert
You can use a Roth IRA to fund a down payment, but you’ll want to speak with an advisor before making this choice.

Building or rebuilding a house is also an eligible use, but certain uses may not be eligible. These can include remodeling a kitchen or building a lounge in the basement, which are not viewed as necessary improvements.

If you withdraw money from your IRS account, you’ll have to use it within 120 days. If you hold on to the money, you’ll be forced to pay a 10% tax penalty.

There are also restrictions on how a “first-time homebuyer” is defined, although the definition seems to be fairly loose. If you have not purchased a primary home in the past two years, you will actually qualify. This definition applies to a spouse as well.

Is it Really a Good Idea to Use Investments as Down Payments?

In all honesty, it is generally not a good idea to use any retirement accounts for your down payment, and you’d have a hard time finding a financial advisor who would recommend this step. Retirement savings are important for your longterm financial stability, and in almost all cases (except this case) the tax penalties from taking early withdrawals are too high.

However, using a Roth IRA may be a good approach if you are struggling to save for a down payment but have significant savings in the retirement account. In most cases, you probably want to make this step only when you have another retirement account, such as a 401(k), that you can depend on for future income.

If your Roth IRA is your sole retirement income, however, it’s wise to leave it alone. With life expectancy increasing every year, and the cost of elderly care on the rise as well, you can never have too much in your retirement; you may have plenty of savings, but knowing that you won’t outlive your money brings an invaluable peace of mind.

Roth over Traditional IRA?

In almost all cases, it’s best to use a Roth IRA over a traditional IRA. This is because if you withdraw from a traditional IRA, you’ll not only pay the early-withdrawal penalty of 10%, you’ll also pay additional income taxes, which are added to your bill because the withdraw in counted as income and added to your annual income tax. Roth contributions, however, come from money that is already taxed, so you don’t have to pay income taxes on that money.

Bring the Right Documents

If you plan on using money in a Roth IRA for a down payment, make sure you bring the right documents. You’ll need items like tax returns and bank statements, and you’ll need to keep all documents related to the money that you extracted from the account.

There are many ways that you can save for a down payment, and the use of a Roth IRA is just one option. It may not be the best choice for everyone, but you should consider it before making a final decision.

Superior Service and Support for Your Mortgage Decisions

If you want more information on structuring your down payment, let the team at San Diego Purchase Loans be your guide!


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Chad Baker, CrossCountry Mortgage   
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