Borrowing From Your Roth IRA for Home Purchase

A Roth IRA is primarily intended for retirement funds, but one of the many advantages to having Roth IRAs is that they can also be used to help you with other kinds of major life changes. Roth IRAs are intended to help middle class workers, who might otherwise experience difficulties paying for certain items. Not many people know that you can purchase a home with the help of a preexisting Roth IRA, and there are certain tax breaks compared with that of a traditional IRA. Keep in mind, however, that there are certain rules to abide by before you borrow from your retirement account to buy a home.

Purchasing a Home

Purchasing a home is not an easy task, especially when you need to come up with a down payment for the mortgage. Even if you have perfect credit, a bank might not extend you a loan if you do not make a sizeable down payment. It can take years to save up for this kind of a lump sum, and many first-time home buyers cannot achieve this on their own without some kind of help.

In order to achieve the down payment, many homeowners borrow money from their IRA accounts. However, the ways in which this work varies depending on the kind of IRA you have. When you contribute to a traditional IRA, you receive a tax deduction for every year that you put money into that account. This gives you an immediate tax break, but you are also required to pay the taxes on the money that you withdraw in the future--this pertains to both your initial contributions as well as any interest you accrue on those investments.

When you take money out of a traditional IRA for a home purchase, you will have to pay the taxes on that money. For example, if you take out $8,000, then you are expected to pay on that money as if it were extra income for that tax year. You would have to factor in this extra expense and decide if it is affordable.

Traditional IRAs do not make sense for many middle class workers because they do not save as much money on taxes compared with a Roth version. All taxes are paid upfront when you contribute to a Roth IRA. Although this is a larger expense at first, you will not have to pay as much money in the future. This is due to the fact that you are only being taxed on your initial contributions, and not on any of the money you make from interest over the lifetime of the account.

When you borrow money from a Roth IRA for a home purchase, you will also receive the tax-free benefits that many accountholders enjoy. You will not pay taxes on this money because you already paid them upfront upon contributing to the Roth IRA. This leaves you with one less expense to worry about when it comes time to purchase your first home.

Rules and Considerations

Before you start borrowing from your Roth IRA for home purchase, you should familiarize yourself with a few rules. First, the government places a limit on the amount you can borrow from your Roth account for a down payment--this limit varies every year based on inflation, so you must research this prior to your home purchase. Also, you must have had a Roth IRA for at least five years before you can borrow money from the account for a home purchase, or else you will be charged a fee.

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