Just because you can, doesn’t mean you should.
It’s an early lesson that applies to plenty of life’s quandaries, including this one: It’s pretty easy to tap your Roth IRA to buy a house, especially as a first-time homebuyer. But should you? Maybe not.
Using a Roth IRA for a home purchase
The Roth IRA rules for distributions make the account a tempting source of cash. To understand them — which is key to following them — it helps to pretend the money in your account is in two envelopes: the contributions you’ve made, and the investment return those contributions have earned.
For the contributions:
You can withdraw the contributions you’ve made to your Roth IRA at any time, for any reason. There is no tax or penalty, no matter how you spend the money or when you take the distribution.
For the investment earnings:
If it’s been at least five years since you made your first Roth IRA contribution:
You can pull out up to $10,000 in investment earnings tax- and penalty-free to put toward your first home. The IRS has an uncharacteristically loose definition of “first” here: You’re considered a first-time homebuyer if you or your spouse haven’t owned a principal residence in the past two years.
The five-year clock starts Jan. 1 of the year you made your first Roth IRA contribution.
If you’re feeling generous, the IRS says you can also put this money toward the first-time home purchase of your child, grandchild or parents.
If it's been less than five years since your first Roth IRA contribution:
You can pull out up to $10,000 of investment earnings to put toward your first home, but you’ll pay income taxes on the distribution. You will not pay an early distribution penalty.
You can also use the money for a child, grandchild or parent who satisfies the first-time homebuyer definition.
The $10,000 ceiling is a lifetime cap, making this a one-time deal for most people, and the funds must be used within 120 days of the distribution. But the flexible rule on contributions means you may never have to get into the stiffer rules around investment earnings. The IRS says that money comes out of a Roth IRA in a certain order: contributions first, followed by money converted from another account, like a traditional IRA or 401(k), and finally earnings.
» Want more detail? See our page on Roth IRA withdrawal rules
Bottom line: If you’ve contributed at least as much as you want to pull out to fund your home purchase, you can take that distribution tax- and penalty- free. If you haven’t, you can take the sum of your contributions plus up to $10,000 of earnings tax- and penalty-free, as long as your first Roth IRA contribution was made at least five years ago and you qualify as a first-time homebuyer.
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Think carefully about using a Roth IRA to buy a home
A Roth IRA may be a relatively easy source of cash for your home purchase, but that doesn’t make it the best source. Here’s what to consider before turning your Roth IRA into a home down payment:
1. Current interest rates
Part of this decision comes down to where your money will work harder: tied up in your home, or invested in the stock market through your Roth IRA. To make that comparison, you want to stack your mortgage interest rate against your long-term investment return expectations.
“Consider where your money will work harder: Tied up in your home, or invested through your Roth IRA.”
Mortgage rates aren’t as good as they once were, but they’re still low enough that most long-term investors will earn a better return by keeping their money in the market. Most experts consider 6% to be a reasonable average annual investment return; that’s a conservative estimate, as historically the average annual stock market return is 10%. Your own return will depend largely on how your money is invested.
When purchasing a home in a low interest-rate environment, it can make sense to borrow more and put down less, especially because the interest is tax-deductible on mortgage debt of up to $750,000.
2. Your down payment options
The ideal down payment is 20% of the home price because it will give you the best chance of getting approved, along with access to lower mortgage rates and lower upfront and ongoing fees.
But that’s a large chunk of cash. If it requires raiding your Roth IRA, it makes sense to consider alternatives, especially when interest rates are low. There are programs that will allow you to buy a home with as little as 3% down.
3. Your retirement savings goal
Specifically, your progress toward meeting it. Sure, there are a few rare birds who are able to overfund their retirement savings accounts. But the rest of us are scraping together every penny just to come close to saving enough for retirement.
In that case, dipping into your Roth IRA could put you back at the starting line. Not only are you spending money you’ve earmarked for retirement, but you’re losing out on the tax-free growth that makes the Roth such a powerful retirement account
Use a retirement calculator to assess where you stand. You can run the numbers based on what you currently have saved, then again with what you’d have remaining if you tapped your Roth for your home purchase. How much would that set you back? Would you be able to recover, and if so, how quickly? These are questions you want to answer before you tap that Roth.