How To Use An IRA For a Home Down Payment
So you are looking to purchase your first home, but are concerned that you don’t have enough money saved up to come up with the down payment on your home. Fortunately, you have been diligently making contributions to your individual retirement account (IRA) over the years and have built up substantial savings in your IRA. You’re left wondering if and how you can withdraw money from your IRA to help you come up with the down payment for your first home and do it without incurring any penalties or taxes.
How Much You Can Withdraw From an IRA
Before getting too excited about using the funds in an IRA to use as a down payment on a home, we first have to discuss the limit on how much can be withdrawn. Only a maximum of $10,000 can be withdrawn from an IRA to use as a down payment on the home. We’ll then discuss what is required to be able to use this provision without incurring a penalty and how taxes are treated.
Taxes and Penalties of a Withdrawal for a Home Down Payment
In a Traditional IRA, keep in mind that tax payments are deferred so the IRA is funded with pre-tax income rather than post-tax income. Although you will not owe the standard early penalty withdrawal, which is 10 percent, you will have to pay taxes on the amount withdrawn. The amount of taxes that will have to be paid will be your ordinary income rate. Therefore, if you’re in the 25% tax bracket and you withdraw $10,000 for a down payment on your home, you’ll owe $2,500 in taxes come tax time on that withdrawal, but you will not get hit with the $1,000 penalty on the early withdrawal.
In a Roth IRA, the taxes on the amount contributed are paid prior the IRA being funded. Therefore, a withdrawal from a Roth IRA would be tax free and penalty free. A withdrawal from a Roth IRA to use to purchase a first home is considered a qualified distribution if the account is open for five tax years. Keep in mind that there are additional rules to consider to ensure that the amount withdrawn would be tax free. This would depend on whether the funds withdrawn are contribution money or earnings. Fool.com has an excellent article on this topic.
Requirements to Obtain IRA Funds For Home Down Payment Penalty Free
In order to qualify to obtain IRA funds penalty free for a down payment on a home, the following elements must be established:
- You must be 59 1/2 or younger.
- You cannot withdraw more than $10,000.
- You have not owned a home within the last two years.
- The home being purchased must be your principal residence.
- You have never previously withdrawn $10,000 from an IRA to purchase a home.
- The funds withdrawn must be used within 120 days of the withdrawal.