What Savings Should I use for the Down Payment on My Home?

Buying your first house is never easy. Whether it’s a matter of scrimping and saving for a down payment, tough markets, broker fees, or balancing priorities, there’s always another complication. Forbes set out some options and explanations for first home buyers (and others) who have assets tied up in retirement accounts, in their recent article, “Should You Use your Retirement Savings to Buy a Home?”

The IRS offers some tax incentives for first home buyers, but as ever it starts out with a definition: a “first time” home buyer is any home buyer who has had no present interest in a main home in the past two years, counting back from the date of acquisition of a new home.  Both spouses must meet this requirement if you’re married. That means that even if you aren’t a literal first home buyer, you might qualify for some tax advantages in purchasing a house.

Normally any withdrawal from a traditional IRA before age 59½ tacks on a 10% penalty to the transaction, but for a first home purchase, the IRS lets you withdraw up to $10,000 of earnings over your lifetime without a penalty. Even without the penalty, that money is still subject to income tax if it comes out of a traditional IRA. For a Roth IRA established at least five years ago, the $10,000 lifetime exemption applies and any income from the Roth IRA is treated as a qualified distribution exempt from penalties and income taxes. If you haven’t had a Roth IRA for at least five years, you can avoid the IRS early withdrawal penalty up to the $10,000 limit, but it may still be taxed as income.

Because contributions to Roth IRAs have already been taxed, you can withdraw your contributions to a Roth IRA in addition to earnings for the purpose of buying a first house (up to the lifetime exemption) without paying further taxes. It’s important to note that the IRS sets a priority for which retirement account can be drawn from first: the Roth IRA is drawn from first.

The rules are different for 401(k)s, and for once the IRS may be the kinder option. Any withdrawal from a 401(k) before age 59½ must be a hardship withdrawal, for which a home purchase qualifies. However, that hardship withdrawal will have a withdrawal penalty applied, and any pre-tax withdrawals or growth in your 401(k) will be taxed.

401(k) loan provisions can provide another way to tap retirement accounts for home buying funds, and some companies are more flexible than others, some even allowing more than the standard five-year pay-back period to repay a 401(k) home loan. However, even if the loan is taken out from your own retirement fund, it still requires you to pay it back, with interest, back into the retirement fund.

Though it sounds convenient, a loan can have serious repercussions on your finances, as all of these options can. If you make late payments on a 401(k) loan, it can lead to the same issues as a late payment or default on any other kind of loan – loss of assets, garnishment of wages, or even loss of your home. With real estate such a key part of most individuals’ retirement plans, be careful to consider the ramifications before you choose to take a loan.

That advice goes for all of the options listed above and in the original article from Forbes – seek advice from a professional before withdrawing from your retirement funds to purchase your first home (or your first home after two years without owning your main residence). Talk to an experienced financial planner or estate planning attorney to make sure you fully understand the consequences and advantages of each option available to you.

Reference: Forbes (May 20, 2018) “Should You Use Your Retirement Savings to Buy a Home?