How to use IRA to buy a house

If you are shopping for a new home, you may consider tapping into your IRA account. The IRS allows IRA account owners to tap into their IRA accounts to pay down payment or closing costs of a home. However, before you withdraw money from your IRA, you should consider the pros and cons of using your IRA to buy a house.

If you are a first-time homebuyer, you may qualify for a tax exemption on your IRA withdrawals. You can withdraw a maximum of $10,000 from your IRA to build or buy your first-time home. You will be exempted from paying a 10% penalty for early withdrawals, but you will still owe income taxes on the distribution.

When to use an IRA to buy a house

IRAs are designed to help workers save for retirement outside the employer-sponsored retirement plan. You can contribute to an IRA up to $6,000 in 2022, or $7000 if you are 50 or older. You can start making penalty-free withdrawals from the account once you are 59 ½ or older. However, if you take an IRA distribution before 59 ½, you will pay a 10% penalty and the regular income taxes.  

First-time homebuyers may be eligible for a hardship withdrawal from an IRA. A hardship withdrawal is a distribution taken to meet an immediate and heavy financial need, and it is capped at the amount needed to satisfy the need. Under this exemption, first-time homebuyers can tap into their IRA accounts and use the funds to buy a home. 

How to withdraw from IRA for Home Purchase

If you qualify to make a hardship withdrawal, you can make a withdrawal from your IRA to purchase a new house. You must not have owned a primary residence in the past two years to qualify as a first-time homebuyer.

The IRS allows withdrawals of up to $10,000 to use when buying a home. If you are married, each spouse can withdraw $10,000 each from their IRAs, bringing the total withdrawal to $20,000.

Apart from withdrawing money to purchase your home, you can also tap into your IRA to help other family members such as a child, parent, or grandchild buy a home. However, the $10,000 limit is a lifetime maximum that first-time homebuyers can withdraw. Once you use this provision, you won’t qualify for the provision again in the future, even if you have multiple IRAs.

If you are below 59 ½ when you tap into your IRA, you will qualify for an exemption from the 10% early withdrawal penalty. You will still owe taxes on the distribution.

How to use a Roth IRA to buy a home

If you want to withdraw funds from a Roth IRA, different withdrawal rules apply. If you are younger than 59 ½, you can take a penalty-free withdrawal from a Roth IRA as long as you have held the account for at least five years and you are using the funds for a first-time home purchase.

If the Roth IRA contributions are not sufficient to pay for the house, you can withdraw an extra $10,000 from the Roth IRA earnings to use for a first-time home purchase. The amount withdrawn must be used within 120 days, and it must go towards the cost of buying the house, or you could owe taxes and penalties on the withdrawal.

Should you withdraw from an IRA to buy a house?

Just because the IRS allows early IRA withdrawals for a home purchase doesn't mean you should. Withdrawing money from an IRA before retirement could mean missing out on tax-free investment growth and setting back your retirement savings by several years.

Unless you opened the IRA to save up for a home purchase, withdrawing from your IRA before retirement is a bad idea. Instead, you should consider other financing options that you can use to obtain funds for the home purchase.

Other options for buying a home

Instead of tapping into your IRA, you could consider the following alternative options:

Borrow from 401(k)

If you have a 401(k) with your employer, you may consider taking a 401(k) loan against your retirement savings. A 401(k) allows you to borrow up to 50% of your account balance up to a maximum of $50,000 tax and penalty-free. You will pay the loan principal plus interest, and the payments will be made to your 401(k). If you are using the 401(k) loan to buy a home, you could be allowed up to 15 years to pay off the loan.

Withdraw funds from a savings/investment account

Instead of withdrawing the funds from an IRA, you can tap into your other savings or investment accounts that won’t compromise your retirement savings. You can also withdraw funds from a money market account or savings account.