401K / IRA Down Payment

What You Need to Know About Using Retirement Funds for a Down Payment

Buying your own home is the American dream, but saving for the down payment can be difficult in today’s economy.  If, however, you have money in one of the many types of retirement accounts, you might be able to use that money for the down payment.  Pulling money from your retirement funds can be great source of income but, you will be depriving yourself of retirement funds in your golden years.  However, buying a house may very well be the largest asset you will ever own and real estate has been a profitable long-term investment for just about EVER!

 

Here is what you need to know about pulling money out of the various types of retirement accounts available today: 

 

The Roth IRA

Pulling money from a Roth IRA, if you have one, will cost you the least in taxes and penalties. This is because you can withdraw up to 100% of your personal contributions at any time without penalty or tax. Additionally, if you have had the account for at least five years, you can withdraw up to $10,000 in earnings in addition to 100% of your personal contributions without paying taxes or penalties for the purchase of your first home.

There is one caveat however: you only have 120 days to spend withdrawn earnings or you may be liable for paying the penalty. Also, for your convenience, your financial services firm will automatically prioritize the withdrawal of all of your contributions from a Roth IRA before any earnings. Additionally, if both you and your spouse have Roth IRA’s you can each pull out the same money individually, collectively doubling the amount of cash you are pulling out so long as all of the previously mentioned rules are adhered to.

 

The Traditional IRA

The next best choice is a traditional IRA.   The rules on withdrawing funds from your traditional IRA allow you to withdraw up to $10,000 for the purchase of your first home, a home for your spouse, children, grand children or parents without paying a penalty.  However, unlike the Roth IRA where personal contributions are made with post tax dollars, the money you pull out will be added onto your taxable income and you will pay standard income taxes on the amount you withdraw.

With a traditional IRA, you must complete the purchase of your home within 120 days of withdrawing the money or you will be liable for a 10% penalty on top of the income taxes.  Also, just like the Roth IRA, your spouse can also withdraw $10,000 from his or her traditional IRA, collectively doubling the amount of the withdrawal.

 

SEP IRAs follow the same rules as Traditional IRA’s.

 

Borrowing from Your 401k

If you have a 401k, you are allowed to “borrow” the lesser of $50,000 or half the value of the account, whichever is less. This is a loan and not a withdrawal so you will have to pay yourself back the principal amount borrowed + a reasonable interest rate.  Though you will pay interest (to yourself), you won’t pay taxes or penalties on the loan amount.

Please keep in mind that this debt, even though owed to yourself, will need to be added to your existing list of liabilities.  The payment for this loan will be added to your monthly debt service amount and will negatively affect your debt-to-income ratio.

Many plans give you up to five years to repay the loan. But keep in mind that five years is a relatively short period of time to repay a large obligation so the payments will likely be high.  Also, If you were to quit or be fired from your current employment, you could be required to pay back the outstanding balance within 60 to 90 days or be forced to take it as a hardship withdrawal…resulting in a penalty and taxes

 

Free advice

Here is a free tip for anyone considering using retirement funds for their down payment:   If possible, roll over an old 401k from a previous employer into an IRA before pulling funds out for a down payment.  Doing so will allow you to avoid paying a penalty for early withdrawal.

 

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