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How a Roth IRA Could Help You Buy Your First Home

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The Roth IRA is one of our favorite ways to save for tax-free income in retirement. However, many people don’t know that it has other benefits as well. With the Roth IRA first-time homebuyer exemption, you can withdraw up to $10,000 to buy your first home. In this article, we’ll cover who can use this benefit, the Roth IRA withdrawal rules, and the risks of using this strategy.

Who can use Roth IRA earnings to purchase their first home

The first-time homebuyer exemption is available to anyone with a Roth IRA who hasn’t owned a home in the last two years. Even if you’ve owned a home previously, as long as it was sold at least two years ago, then you qualify.

Under this exemption, you can withdraw up to $10k in earnings without penalties or taxes. The only caveat is that you must have made your first Roth IRA contribution at least five years ago.

This strategy is a popular choice for homebuyers who have had trouble saving up for a down payment or the closing costs on a mortgage. By withdrawing money from your Roth IRA, you can buy your home sooner. This allows you to take advantage of recent stock market gains. And, you can buy now before price increases cause your dream home to be out of reach.

Overview of Roth contribution/withdrawal rules

Roth IRAs are considerably more flexible than a Traditional IRA when it comes to withdrawals. Traditional IRAs require that you wait until you are at least age 59 1/2 before withdrawing, otherwise, you’ll owe a 10% penalty on your withdrawal.

By comparison, Roth IRAs allow you to withdraw your contributions at any time if it has been at least five years since your first Roth IRA contribution. Even if your current Roth IRA account has been open for less than five years, this is true. While most advisors discourage early withdrawals from your retirement account, you are not penalized if you withdraw contributions before 59 1/2.

However, if you withdraw earnings from your account before retirement age, then those withdrawals are taxable and subject to a 10% penalty.

Exemption for first-time homebuyers and how it works

If you decide to withdraw money from your Roth IRA to buy your first home, then you need to follow specific rules to avoid taxes and penalties.

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  • Must qualify as a first-time homebuyer. Qualification counts as not having owned a principal residence in the previous two years. It is ok to have owned a home before, but you must have sold it at least two years ago.
  • Up to $10,000 can be used to buy the home. As long as all of the money withdrawn is used for qualified acquisition costs, then the standard 10% penalty on earnings is waived. Any amounts over $10,000 are subject to taxes and the 10% penalty.
  • Money does not have to be for a down payment. Qualified acquisition costs for the first-time homebuyer exemption include the costs of buying, building, or rebuilding a home. Additionally, the usual and reasonable settlement, financing, or other closing costs qualify.
  • Lifetime limit of $10,000. If you’ve used this strategy before, the amount you withdrew previously counts towards your $10,000 lifetime maximum.
  • You must close on your home within 120 days of receiving the money. Because of this deadline, it is wise to hold off on requesting a withdrawal until you have a home under contract and are certain that you will complete the purchase. Keep in mind how long it will take your investment company to process your request. And don’t forget to factor in how long it takes to receive the funds.
  • Does not have to be your home. Withdrawals can be used to pay qualified acquisition costs for the main home for you or select relatives. These relatives include your spouse, your child, your grandchild, or a parent or ancestor.

Risks of using funds from Roth IRA

Withdrawing from your Roth IRA can be appealing, but there are downsides to this strategy. Roth IRA balances grow tax-deferred and withdrawals are tax-free in retirement. Once you withdraw the money, you cannot replace it at a later date.

Assuming that you have a 10% average return, a $10,000 withdrawal today at age 30 is worth $320,000 at age 65. The potential lost gains can have a serious impact on your retirement income. And this strategy is especially risky if these are only funds put away for retirement.

Homeownership can be expensive as well. If you’re stretched so thin to buy the house that you need to withdraw from your retirement accounts, how will you afford other homeownership costs? Most new homeowners want to personalize the home or buy new furniture. Roofs, HVACs, water heaters, and appliances need to be replaced. And many homes have higher utility bills than an apartment.

If you haven’t started your Roth IRA yet, here’s how to open a Roth IRA.

Bottom line

The Roth IRA first-time homebuyer exemption is a useful strategy if you’re having trouble saving up to buy a home. It can accelerate your ability to buy a home and take advantage of low mortgage interest rates. However, before pursuing this path, talk with a financial advisor or check out our list of the best investment apps. They can help you understand the pros and cons of this choice.

Additionally, speak to a broker from our list of the best mortgage lenders. They can explore low-cost and low-down-payment mortgage options that may allow you to keep your Roth IRA money invested.

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