The Roth Advantage Part 2: First Time Home Buyers
You should NEVER consider a retirement fund an emergency fund, however; the fact remains that there are less barriers and penalties to accessing funds from a Roth IRA early than from a Traditional IRA.
There are ways for first time home buyers to access some funds from retirement accounts without “penalty”. Though you may be able to avoid an early withdrawal penalty, you will be lowering the amount in your retirement account, and potentially paying tax. You would likely be purchasing your first home many years before you plan to retire, depleting your account when it has the most time to grow. This is a complicated decision. It is important to understand the differences between how you could access funds early from Traditional or Roth IRAs.
A first-time homebuyer can access up to $10,000 from either a Roth or Traditional IRA to contribute towards a down payment[i]. Any funds taken out from a Traditional IRA, for any reason, including a first-time home purchase would be taxed as ordinary income. The tax deferred nature of the Traditional IRA is its biggest advantage, so using funds from a Traditional IRA to help fund a home purchase will forfeit some of that benefit while shrinking your nest egg.
Whether or not your home turns out to be a good investment depends on several factors, homeownership is often more expensive than people realize and tapping into a retirement account to buy a home has an enormous opportunity cost. Which means you’re making it harder for that to be a good investment because the money won’t have the chance to grow in an account for your retirement with favorable tax treatment anymore.
With a Roth IRA, you can take out contributions at any time for any reason without a tax consequence since it’s already after-tax dollars (assuming the account has been open for at least 5 years)[ii]. The Roth IRA owner can also access up to $10,000 of profit for a first-time home purchase, and again if you have had the Roth for more than 5 years that would be tax free.[iii]
Tapping into your retirement account to buy a home should not be your first choice, but it’s nice to know what options could be on the table. You have the best chance of growing your nest egg if you contribute the maximum into your retirement accounts for as long as possible. Taking funds out of your retirement account before retirement age, with or without penalty and or tax, means you will have a smaller principal to hopefully compound over time. Your retirement money will serve you best in retirement and should be invested in a well-diversified portfolio for the long haul. Any investment involves the risk of loss of principal but the more diverse your investments and the longer your time horizon the better your chance is to mitigate that risk.
If your income is at or approaching limits for contributing to a Roth IRA the next piece in this series will discuss a potential way for you to contribute to a Roth IRA using Roth conversions. It’s never too early to start thinking about retirement. The earlier you start the more time you have for growth. You work hard for your money, we work hard so your money can work for you.
A Roth IRA distribution is qualified if you’ve had the account for at least five years and/or the distribution is made after you’ve reached age 59½, because of your total and permanent disability, in the event of your death or for first-time homebuyer expenses. Distributions made prior to age 59 1/2 may be subject to a federal income tax penalty. If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings
You should always consult a tax professional and though this piece contains some tax information it should not be considered tax advice.