The IRS allows a one-time exception for first-time homebuyers that want to tap into their IRA to put money down on a home. That exception saves you a 10% penalty, which could amount to quite a bit of money. But just because you can withdraw the money (even if you aren’t a first-time homebuyer), does it mean that you should?
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WHERE DO YOU STAND FOR RETIREMENT?
The largest question you should ask yourself is how you look for retirement. Are you in good shape? This means you’ve saved for retirement since your first job and have more than enough to get you where you want to be in retirement. Not too many people can say they are at this point.
The ideal situation would be if you have had a 401K for a long time, and you’ve regularly contributed to it. On top of the 401K, you also have an IRA or even several IRAs. By withdrawing $10,000 from your IRA, you won’t hurt your retirement funds. Yes, you’ll lose a little bit, but you’ll invest it in real estate, which can be a lucrative investment for your retirement as well.
If you don’t have such a situation, you may want to leave your retirement funds alone. This is especially true if you’ve just started saving recently. You need the compound interest to help your retirement fund grow. Without it, you could come up short in retirement, forcing you to work much longer than you planned.
CAN YOU AFFORD THE HOME?
Something you should give careful consideration to is if you can afford the home. If you don’t have the money for the down payment, what are you going to do if something goes wrong with the home? If you suddenly need a few thousand dollars, but you don’t have an emergency fund to speak of, you could find yourself in over your head.
If you don’t have any money saved aside from the IRA, we suggest that you leave it alone. Instead, wait until you have funds separate from your retirement fund that you can put down on the home. Not only that, but we encourage you to have an emergency fund with at least three months’ worth of mortgage payments and other monthly expenses just in case something does happen. There’s no sense in making yourself house poor.
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DID YOU EXPLORE ALL OF YOUR LOAN OPTIONS?
Did you know that you probably won’t need a 20% down payment? It’s true. You may even be able to get away with no down payment if you are a veteran or you buy a home in a rural area.
VA home loans are for veterans of the military. If you served 181 days during peacetime or 90 days during wartime and had an honorable discharge, you are likely eligible. The best part about the VA loan is that you don’t need a down payment. You can secure 100% financing for your loan. This allows you to leave your IRA alone.
USDA loans also provide 100% financing and you don’t have to be a veteran. You just have to be willing to live in a ‘rural’ area as determined by the USDA. The areas they consider rural are often just outside of the city lines. The only catch is that your total household income cannot exceed the USDA guidelines. In general, this means you can’t make more than 115% of the average income for your area.
Even if you don’t qualify for one of the above loan options, the FHA loan requires just 3.5% down on a home. Better yet – they allow 100% of those funds to be a gift from a relative, employer, or charitable organization. Again, this gives you the opportunity to leave your IRA alone and let it grow.
THINK OF THE OPPORTUNITY COST
One thing we really want you to consider is the opportunity cost of withdrawing from your IRA. We’ve mentioned compounded interest several times so far because it’s so important. When you deposit funds in an IRA, they grow interest. That interest then also grows interest and it keeps going on until you reach retirement age and start withdrawing the funds.
If you withdraw those funds early to buy a home, you lose that opportunity. Chances are that your home isn’t going to appreciate at nearly the rate you would have earned in your IRA account. Again, if you have more than enough saved for retirement, this won’t be a big deal. If the IRA is your only retirement account or you are just starting out, it’s best to leave the account alone.
Withdrawing from your IRA to buy a house can help in some cases, but not many. We suggest that you talk to your tax advisor before considering this option. We also encourage you to explore all of your loan options, as there are many out there that require little to no down payment, allowing you to leave your IRA alone.