Buying a home is expensive and is one of the largest financial investments most people make in a lifetime. Saving enough money to make a down payment can take several years. Taking loans from your retirement plans or withdrawing money from your Individual Retirement Account (IRA) should be done as a last resort unless you meet certain requirements that will spare you from penalties and fees. Buy a home with a traditional IRA or a Roth IRA.
- Determine what sort of IRA you will be using. With a traditional IRA, you pay taxes at the time of withdrawal, usually when you are retired. With Roth IRAs, the money you contribute is taxed, so you do not have to pay any taxes when you withdraw it.
- Review Internal Revenue Service (IRS) guidelines. First-time homebuyers are able to use $10,000 of their traditional IRA funds towards the purchase of a new home, without incurring a 10 percent penalty for taking the money before the age of 59 1/2.
- Determine if you qualify as a first-time homebuyer. The IRS defines a first time homebuyer as someone who has not owned a main home during the 2 years prior to the date that a home will be purchased with IRA funds.
- Make sure your spouse qualifies as a first-time homebuyer as well, if you are married and buying the property together. Each of you may take $10,000 from your traditional IRAs.
- Purchase the home within 120 days of your IRA withdrawal.
- Use the money for other acquisition costs, including building or repairs to the house, closing costs and financing fees.
- Prepare to pay taxes on your IRA withdrawal. You will need to pay federal and state taxes on the money you take from your IRA, because it will be considered income.
- Pay the penalty if you are not a first-time homebuyer. If you do not qualify as a first-time homebuyer, you can still take money from your IRA to buy a home. In addition to the taxes, you will be charged a 10 percent penalty on the amount you withdraw.
- Use Roth IRA contributions as a down payment. If you have a Roth IRA, you can use as much of your original contribution as you want, without any tax or penalty. You are not required to be a first-time homebuyer.
- Withdraw up to 10 percent of your Roth IRA earnings without a penalty.
- Verify how long you have had your Roth IRA open. If you have had it open for at least 5 years, you will avoid taxes on the withdrawal of earnings.
- Try to time the purchase of your home for early in the year. The more interest you pay on your mortgage throughout the year, the more you can deduct on your taxes for that year. Because you may be taxed on your IRA withdrawal, getting the highest mortgage interest deduction you can will help offset that distribution.
- The $10,000 withdrawal can also be used to buy a house for a spouse, child, grandchild, parent or grandparent.
- Work with a qualified financial planner or tax specialist before taking money out of your retirement plan, or making a large purchase, such as a home.
Finally…. If your home purchase falls through, be sure to roll the IRA money back into a retirement fund within 120 days, or you will face taxes and penalties.