Using a Roth IRA for Your Down Payment: What Homebuyers Need to Know

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Updated on Wednesday, January 30, 2019

Home For Sale Sign in Front of Snowy New House
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Investing in a home is age-old financial advice and part of the traditional American dream. Although a home may be the largest purchase of your lifetime, your mortgage payments, unlike rent, will go toward an asset you actually own, helping you build wealth and equity.

But purchasing a home can be challenging considering even a small fraction of the purchase price amounts to thousands of dollars.

For instance, if you were looking at a $220,000 single-family home and qualified for the FHA’s low 3.5% down payment option, you’d still have to pony up $7,700 — or $22,000 to put 10% down. That might seem impossible to achieve considering most Americans don’t have $1,000 to spare.

However, there is one potential source of funds you may not have considered: your Roth IRA. Thanks to some special stipulations put in place by the IRS, it is possible to use your Roth IRA for a down payment on a home, whether you’re a first-time buyer or in the market for your next abode.

But is it worth it to tap your retirement fund to buy a house? What rules and regulations govern how much you can take? Here’s what you need to know.

Roth IRA rules for first-time homebuyers

In order to make the purchase of a home possible, the IRS has made special Roth IRA exceptions for first-time homebuyers. While you’d usually pay an additional 10% tax on distributions made before the age of 59 and a half, you can take up to $10,000 in penalty-free distributions to “buy, build or rebuild a first home.”

Settlement, financing and closing fees all count as “qualified acquisition costs,” and the first-time homebuyer may be the account owner (you) or your spouse, child, grandchild, parent or “other ancestor.” According to the IRS, eligible first-time homebuyers are those who have had no interest in a “main home” during the two years leading up to the date they take distributions for homebuying purposes. That means it’s possible to have purchased a home before and still qualify under this rule.

Keep in mind that this rule is also true of traditional IRAs, but with one important caveat: Any distributions taken early will count toward your taxable income for the year. Since you’ve already paid taxes on Roth contributions, you’ll be able to make the withdrawal without any additional required payments.

However, the first-time homebuyer clause for Roth IRAs is still subject to the five-year rule, which means five years must have elapsed since the first taxable year in which contributions were made to the account. If the Roth has been open for less than five years, you will avoid the 10% early withdrawal penalty if you meet the first-time homebuyer guidelines but will be required to pay income taxes on distributions.

Of course, the contributions you make to your Roth IRA — minus capital gains made through compound interest — are always available for withdrawal, even before those five years are up. However, taking that money out of your account means forfeiting the chance for valuable growth, which will decrease the size of your nest egg upon retirement.

Using your Roth IRA for a home down payment

Even if you don’t qualify as a first-time homebuyer per the IRS definition, you can tap your Roth IRA for a down payment because any contributions you make are always available for tax-free withdrawal. You can even withdraw earnings if you like — though if you haven’t yet reached age 59 and a half and don’t qualify as a first-time homebuyer, you’ll be faced with a 10% early withdrawal fee as well as regular income taxes.

On the other end of the spectrum, if you and your spouse are both qualified first-time homebuyers — which is required in order to take advantage of this clause — you’d each be permitted to take the $10,000 tax-free qualified distribution, allowing you to put a total of $20,000 toward your new home.

Should I use a Roth to buy a house?

Given the cost of a home purchase, it’s easy to see why tapping your Roth IRA for a down payment is an attractive option. As beneficial as this clause can be for strapped homebuyers, there are a few potential drawbacks to consider before you make your decision.

For one thing, the $10,000 limit is lifelong, which means you won’t be able to take advantage of the rule more than once — unless you’re withdrawing less than the total approved amount, in which case it might make more sense to wait until you can save it up on your own. Malik S. Lee, certified financial planner and founder of Atlanta-based Felton & Peel Wealth Management, cautioned buyers against immediately turning to their Roths as a home-funding option.

“Imagine if you had pulled out that $10,000 in 2008 and bought a house — and then lost the house” in the famous housing bubble, he mused. Not only would you have lost a chunk of your retirement (and its growth potential), but all your investments tied to that account would be kaput as well.

Fortunately, there are a variety of alternatives to tapping your Roth IRA for a down payment. You could consider local assistance programs in your area, which sometimes offer down payment grants in exchange for your attendance at financial education courses.

You also might be able to borrow the money from family or take out a small loan with your local bank to cover the down payment. That way, you’ll be able to start building your home equity without sacrificing part of your retirement fund.

Bottom line: using a Roth IRA to buy a home

Although a Roth IRA can be used to help fund the purchase of a home, you should always consider the best option for you and your financial needs. Here are the cut-and-dry rules to using your Roth IRA for a home purchase:

  • If the account has been open for five or more years, qualified first-time homebuyers can take up to $10,000 in tax-free distributions without paying the additional 10% penalty.
  • Other buyers can pull contributions out of their accounts tax-free or take taxable distributions and pay the penalty.
  • Married couples that both qualify as first-time homebuyers can combine their efforts and take a total of $20,000 in tax-free distributions.
  • This rule comes with a lifetime $10,000 limit, so once you use it, you can’t pull from it again in the future.