Using Retirement Funds to Buy Your Home
USING RETIREMENT FUNDS TO BUY A HOUSE. CAN I AND HOW?
Buying a new home is a fun, exciting time in your life! It is also one of the pivotal decisions you shall ever make since there are a multitude of aspects to mull over. Where would you prefer to reside? How are the educational institutions in that region? Are there recreational parks and walking routes in the vicinity? How much space do you need or desire in your dwelling? And one of the most significant considerations: Can you financially afford to purchase a house? In pondering over this last question, you may question if utilizing retirement assets to assist with a home acquisition is a prudent option or even a feasible one.
When considering retirement assets as a potential method to assist with covering the expenses of a new dwelling (or, potentially, the down payment on a new dwelling), there typically are two common avenues taxpayers can contemplate: A 401(k) plan or an IRA. Ordinarily, with either plan, if you are under age 59 ½ and extract funds from the fund, you will incur a 10% early withdrawal penalty (plus any penalty imposed by your state) unless you meet the criteria for an exemption. Besides that, you might be subject to income tax on whatever amount you withdraw. Let us individually examine each of these options. Let’s look at each of these options individually.
Option 1: 401(k) funds
When taking funds from a 401(k), you generally have two possibilities:
You can take a loan from your account. A loan from a 401(k) typically must be reimbursed over a five-year period. However, this timeframe will be truncated if you exit your job or get laid off. The cap on the amount you can borrow is the lesser of:
$10,000, or half of your vested balance (whichever is more),
OR $50,000.
You can make a "hardship withdrawal." Whether a home acquisition is regarded as a hardship withdrawal is contingent on your employer, but you would still be subject to a 10% penalty if you are under 59 ½.
Though a loan may appear to be the perfect choice in this scenario (given that there are no income tax implications, and no penalty is enforced), there are several factors to keep in mind when contemplating a 401(k) loan. During the "repayment period" of the loan, all funds you funnel into your 401(k) account are regarded as loan repayments and not contributions (i.e., no employer match and no tax break), and you forfeit the growth opportunity you would have received if you had not taken out the loan. Additionally, a 401(k) might potentially work against you in obtaining funding for the remaining mortgage, as it could be included in your debt-to-income ratio.
Option 2: IRA funds
Usually, you will have one of two types of IRAs:
Traditional IRA – As mentioned above, if you extract funds from your traditional IRA and are under 59 ½, you will face a 10% early withdrawal penalty. However, if you are a "first-time homebuyer" (typically defined as you - or your spouse, if applicable - not having owned a home in the last two years), you may qualify for an exemption to the 10% penalty on up to $10,000. If you are married, you and your spouse can each make a $10,000 withdrawal without penalty. Remember, though, that the funds in your traditional IRA may be pre-tax, and when you withdraw, you will have to pay income tax on that withdrawal.
Roth IRA – If you have maintained a Roth IRA account for a minimum of five years and are over 59 ½, you will not encounter any income tax implications or penalties on a withdrawal (this is excellent news!). However, if you have not held a Roth for at least five years or are not over 59 ½, you might be subject to the 10% penalty on any distribution of earnings (bear in mind that a Roth IRA comprises post-tax funds, so income tax has already been remitted on your contributions). The good news is that, akin to a traditional IRA, you (and your spouse) can withdraw up to $10,000 (as a qualified first-time homebuyer) without penalty.
I heard I can buy property in my IRA – Can I buy my house that way?
After perusing all this, you may conclude that you prefer not to withdraw funds from your IRA accounts or borrow from your 401(k). Reducing the account balance diminishes any growth you accumulate in that account, and the tax impact for incorporating the income from a traditional IRA can be quite significant. You also might lack the income to pay a mortgage and a 401(k) loan. As the amount you can withdraw from a traditional IRA would be subject to a penalty if you are not yet 59 ½ years old, and the penalty exemption amount for first-time home buyers is low, you very likely would need to withdraw more from the account than you can exempt from the penalty. Housing prices have soared throughout the pandemic and are just now showing signs of cooling down. Thus, you might contemplate if there is another alternative.
If you have been browsing the internet for information regarding using your retirement assets to acquire property, you may have encountered some websites discussing procuring real property in your IRA account. Although it is true that your IRA can encompass any variety of investments, including real property, in addition to conventional stocks and bonds, what many of these websites neglect to elucidate are the limitations and risks of purchasing real property using an IRA and retaining that property as an IRA asset. Purchasing property in an IRA is highly complex, and you cannot procure property in an IRA for your personal use, such as a personal residence. Doing so would instantly disqualify your IRA as a tax-exempt IRA account, and the entire balance would be regarded as distributed to you. Depending on your account balance, this could be considerably burdensome in terms of taxes.
Buying a home is a big decision. Figuring out how to pay for it can be an even bigger decision, and you will want to avoid incurring a large tax bill for doing things incorrectly. As with all big decisions, you may want to consult a tax professional for advice before you make your financial moves. If you are still unsure about your situation and want expert advice, you can click this link to set an appointment to speak with a Tax Expert from Lisa Brugman, EA & Associates.
