How to Buy a Home With a Roth IRA
Many potential homeowners don’t know that you can use a Roth IRA to buy a home. Although the Roth IRA has plenty of downsides, including income restrictions, it has favorable rules for both current and first-time homebuyers.
A Roth IRA is funded with after-tax contributions and grows tax-free, allowing the owner to take distributions without any taxes or penalties once they’re at least age 59.5. Those who wait until age 59.5 and have had their account open for at least 5 years, the salient points of this article don’t matter because the entire Roth IRA can be liquidated without issue. However, for those who take a distribution before the later of those two dates, it certainly helps to understand the role that each plays in making your housing dreams come true.
When it comes to buying a home with a Roth IRA, there are four components to consider, and we’ll explore each in detail:
Contributions
Earnings
Conversions
Is this a good idea?
Roth Contributions
You can always take distributions of prior contributions from your Roth IRA with no tax or penalty consequences. If you haven’t been keeping track of your contributions over the years, obtaining these amounts from your brokerage records will be your first priority. Not only will this tell you how many dollars of contributions you can remove, but it will also prep you in advance for an audit should the IRS have any questions.
For example, let’s say your Roth IRA balance is $80,000, of which $60,000 is composed of contributions. You are allowed to withdraw up to $60,000 to fund your housing down payment without any taxes or penalties, even if you’re not a first-time homebuyer. While this may seem confusing, remember that Roth IRA contributions are made with after-tax dollars. Although you will still receive a 1099-R from your stock broker at tax time, you won’t owe any tax.
Roth Earnings
Roth earnings can be used to purchase a home, but the distribution rules are more complex than that of contributions. In essence, Roth IRA earnings have two layers of costs to manage, taxes and penalties.
To avoid taxes, you also need to be a first-time homebuyer and have had your Roth IRA open for at least 5 years. If you have multiple Roth IRA accounts, the date of the first account being open is all that matters. The distribution of earnings must be $10,000 or less to be tax-free.
In addition to taxes, distribution of earnings from a Roth IRA before age 59.5 are subject to a 10% early withdrawal penalty. The IRS makes an exception when you’re buying a first home, but only if your distribution of earnings is $10,000 or less. There is no 5-year seasoning required.
Roth Conversions
If you or your financial advisor have converted a Traditional IRA into a Roth IRA at any point, you need to wait 5 years for each conversion to season before being able to remove it without taxes and penalties. Any earnings on converted amounts inside the Roth would follow the earnings rules previously discussed.
Is This a Good Idea?
It’s hard to say at surface level whether or not a Roth IRA is a “good” account to withdraw from for purposes of funding a home. On the one hand, a Roth IRA allows money to grow and be distributed tax-free, so it’s a powerful tool to grow net worth. On the other hand, home ownership also has meaningful tax advantages, and that’s true on both the personal and investment side (although the technical tax aspects are very different).
As both a comprehensive financial advisor and mortgage loan originator, I can help you navigate financial considerations before, during, and after your home loan process. Please call, text, or email me with any questions.
