Use IRA for Down Payment?

Jun 6, 2012 by

financial puzzle pieceIf you’re itching to take advantage of what may turn out to be a prime opportunity to buy a home but don’t have as much down payment as you’d like or need, raiding your IRA is an option. Let’s talk first about what’s possible, and then what’s sensible.

Use Roth IRA Money for a Down Payment

This one’s simple: You can withdraw contributions—but not earnings—from a Roth IRA you’ve held at least five years anytime for any reason with no tax consequences.

Use Traditional or SEP IRA Money for a Down Payment

Here’s where things get complicated. You may withdraw money from a Traditional or SEP IRA for a house down payment and pay only your normal income tax rate on the withdrawal (not the usual 10% penalty for early withdrawals) if you meet these criteria:

  • You’re younger than 59½.
  • You haven’t owned a house for at least two years. (Strangely, this is the IRS’ definition of “first time homebuyer.”)
  • The home must be your principal residence (the definition of which is known with certainty by no one).
  • You must buy the house within 120 days of the IRA withdrawal.

Pass the test above, and here’s what the IRS will let you do:

  • Withdraw up to $10,000 from your Traditional or SEP IRA. (If you’re buying the house with another party, you may each withdraw up to $10,000 from your own IRAs.)
  • Pay tax on the withdrawn amount at your regular income tax rate but pay no early withdrawal penalty.

IRA Withdrawal Strategy Cautions

Talk to your IRA custodian before making a withdrawal from a Traditional or SEP IRA. It may withhold taxes from your withdrawal, so your expected $10,000 bump to your down payment may turn out to be something considerably less.

The $10,000 withdrawal limit is lifetime. Once you’ve withdrawn that much from your IRA for a home down payment, you’ve exhausted that option, forever.

Is Withdrawing Money From an IRA for a House Down Payment a Smart Money Choice?

Almost all the time, I’d advise against an early withdrawal from an IRA for a house down payment. Retirement accounts are for retirement, no?

If you’re in what would be a very unusual situation of owning an IRA with loads of money so that your retirement is set but you’re short of ready cash for some reason to make a down payment, perhaps withdrawing from your IRA to make the transaction possible or avoid private mortgage insurance premiums could make sense.

But if you’re like nearly everyone we all know, and you’ve got a lot of work and saving to do to secure the sort of retirement lifestyle you’d like, going backward by taking money out of a tax-advantage account isn’t likely to pay off for you. Think of an early withdrawal as sacrificing a bit of your retirement lifestyle in favor of your pre-retirement lifestyle. Maybe that’s a choice you want to make—who am I to say?—but do it consciously, after lots of deliberation.

What Do You Think?

Can you envision circumstances when withdrawing IRA money for a house down payment would be financially prudent?

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