Can You Use Your IRA To Buy a House?

Yes, you can use your individual retirement account (IRA) to buy a house, but there are rules and potential tax implications. For a first-time home purchase, both traditional and Roth IRAs allow you to withdraw up to $10,000 at any time or age—whether the money consists of earnings or contributions—without the usual 10% early withdrawal penalty. However, you may still owe taxes. If you’re thinking about using IRA funds for purchasing a home, you should take an in-depth look at the pros and cons, and consider the long-term impact it could have on your retirement savings to help you decide if it is the right move for you.

First-Time Homebuyer Exemption

A first-time homebuyer is someone who hasn’t owned a home as their primary residence in the previous two years, the IRS says. If you are married, your spouse must also meet this definition of a first-time homebuyer. The IRS allows a first-time homebuyer to withdraw up to $10,000 from an IRA without incurring the 10% early withdrawal penalty, which normally applies to distributions taken before age 59½. For a withdrawal of earnings from a Roth IRA to escape tax and penalty, the account or any other Roth IRA owned by the account holder must be at least five years old. The first-time homebuyer exemption applies to both traditional and Roth IRAs, but the tax treatment is different. To qualify, the funds must be used within 120 days to buy, build, or rebuild a first home for yourself, a spouse, a child, grandchild, or parent. The $10,000 limit is a lifetime cap per individual.

It is important to note that if you have received a first-time homebuyer distribution and the acquisition of the home is canceled or delayed, generally, you may contribute the amount of the distribution to an IRA within 120 days of the distribution to avoid paying income tax or the 10% additional tax on early distributions.

Traditional IRA

When using money from your traditional IRA to buy a home using the first-time homebuyer exemption, you can withdraw up to $10,000 without paying the 10% early withdrawal penalty if the funds are used to buy, build, or rebuild a first home. However, the amount you withdraw is still subject to ordinary income tax since traditional IRA contributions are made with pre-tax dollars.

Roth IRA

Like the traditional IRA, you are allowed to withdraw up to $10,000 of earnings from your Roth IRA without the 10% early withdrawal penalty if the funds are used to buy, build, or rebuild a first home. To qualify for a tax-free and penalty-free withdrawal, the portion of the distribution allocable to earnings must have been open for at least five years from the beginning of the year for which you first set up and contributed to your Roth IRA. Unlike traditional IRAs, Roth IRA contributions can always be withdrawn tax-free and penalty-free because these contributions are made with after-tax dollars. Only the earnings portion of your Roth IRA is subject to these rules.

Pros and Cons of Withdrawing Early From Your IRA

Withdrawing early from an IRA is a major financial decision that should not be taken lightly. Using funds from your IRA to buy a home, even under the first-time homebuyer exemption, still comes with potential tax implications and long-term financial consequences. It’s crucial to evaluate all options and consider the long-term impact on your retirement funds before proceeding.

Pros:

• Penalty-Free Withdrawal (First-Time Homebuyer Exemption): With the first-time homebuyer exemption, you can withdraw up to $10,000 from a traditional or Roth IRA without paying the 10% early withdrawal penalty.
• Jumpstart Homeownership: Using IRA funds can help you purchase a home sooner than you might otherwise be able to, allowing you to start building equity in an asset you own, rather than continuing to rent.
• Flexible Use of Funds: The withdrawn money can be used for various home-acquisition expenses, including closing costs or a downpayment. You are also able to use your lifetime limit of $10,000 toward helping a family member such as a child, grandchild, or parent, if you don’t need to use it all yourself.

Cons:

• Potential Tax Liability: Even though the early withdrawal penalty is waived, you may still owe income taxes on the amount withdrawn from a traditional IRA. This could result in a higher tax bill for the year of the withdrawal.
• Reduced Retirement Savings: Taking money out of your IRA means you’ll have less saved for retirement, potentially impacting your long-term financial goals and growth due to lost compounding interest over time.
• Lifetime Limit on Exemption: The $10,000 first-time homebuyer exemption is a lifetime limit, so once you use it, you won’t be able to get this tax-advantaged exemption again. Additionally, the amount is limited to only $10,000, which may not meet your entire need when trying to pull together a downpayment or come up with closing costs.

The Financial Impacts of an Early Withdrawal

While the first-time homebuyer exemption allows an IRA account holder to withdraw up to $10,000 without an early withdrawal penalty, doing so can still impact long-term financial growth. For instance, if a 30-year-old withdraws $10,000 from their IRA and the account would have earned an average annual return of 5%, that amount could have grown to nearly $55,000 by age 65. By using the funds now, they could miss out on around $45,000 in potential gains—significantly reducing the value of their retirement savings.

Alternatives to Using Your IRA for a House

Before tapping into your IRA to finance a home purchase, it’s important to explore other options that may better preserve your retirement savings. While the first-time homebuyer exemption offers penalty-free access of up to $10,000 of funds, there are alternative methods that could help you achieve homeownership without sacrificing your long-term financial goals. Exploring these possibilities can provide the cash or beneficial financing options you need while keeping your retirement plan on track.

401(k) Loan

A 401(k) loan allows you to borrow from your retirement savings, typically up to 50% of your vested account balance or $50,000, whichever is less. However, if 50% of your vested balance is less than $10,000, some plans may permit you to borrow up to $10,000. These loans typically are expected to be repaid with interest in five years, although if the loan is used to purchase a primary residence, repayment terms may be extended

Using a 401(k) loan for a home purchase offers several advantages. It provides quick access to funds without a credit check, and the repayment interest goes back into your retirement account—so essentially, you are paying yourself to borrow against your own retirement account. Additionally, it doesn’t affect your credit score or debt-to-income ratio, which can be beneficial when applying for a mortgage.

There are some risk factors that you should consider before borrowing against your 401(k). If you leave your job before repaying the loan, the outstanding balance may become due immediately. Failure to repay on time can result in the loan being treated as a taxable distribution, subject to income tax and possibly a 10% early withdrawal penalty. This risk factor can be mitigated, though, by rolling over the outstanding loan balance to an IRA or another eligible retirement plan by the due date. Furthermore, while the loan is outstanding, you may miss out on potential investment gains, which can impact your long-term retirement savings.

VA Home Loan

A VA loan is a mortgage option backed by the U.S. Department of Veterans Affairs. Advantages of a VA loan are that it typically requires no down payment, offers competitively low interest rates, and imposes limited closing costs. Further, a VA loan does not require the borrower to purchase private mortgage insurance (PMI), which can result in substantial savings over the life of the loan. To be eligible for a VA loan, applicants must obtain a Certificate of Eligibility (COE), which verifies their service history and duty status. Generally, this benefit is available to veterans who meet specific length-of-service requirements, active-duty service members, certain members of the National Guard and Reserves, and some surviving spouses. In addition to meeting service criteria, borrowers must also demonstrate satisfactory credit and sufficient income to qualify for the loan. The home purchased must be for a primary residence.

FHA Home Loan

An FHA loan is a government-backed mortgage insured by the Federal Housing Administration, designed to help individuals, who may not otherwise be able to buy a home, qualify for financing. Key benefits of an FHA loan are a low down payment requirement, which can be as little as 3.5% for borrowers; low closing costs; and, more flexible qualification criteria.

However, there are some drawbacks. FHA loans require borrowers to pay mortgage insurance premiums (MIP), both upfront and annually, which increases the overall cost of the loan. The loan limits may also be lower than those of conventional loans, which could restrict the ability to purchase the desired home. Still, for buyers with limited savings or credit challenges, an FHA loan can be a valuable tool toward owning a home.

The Bottom Line

Using your IRA to buy a house is possible, particularly with the first-time homebuyer exemption, which allows you to withdraw up to $10,000 without facing the typical early withdrawal penalty. However, this decision should not be made lightly. While accessing your IRA funds can help you achieve homeownership sooner, it can also significantly impact your long-term retirement savings by reducing the benefits of compounding growth. It’s crucial to weigh the immediate advantages against the long-term effects of taking retirement money out of your IRA.

Before tapping your IRA, consider alternative ways of financing a home purchase. Some alternatives might better protect your retirement nest egg. Options like FHA loans offer low down payments and flexible credit requirements, while VA loans provide eligible veterans and service members with the chance to buy a home with no down payment and favorable loan terms. Another option could be borrowing against your 401(k), which allows you to access funds without permanently removing them from your retirement account. Exploring these alternatives can help you make a more informed decision that supports both your short-term goals and long-term financial goals.