First-Time Homebuyers: Should You Use Your Roth IRA for the Purchase?

Here’s what to consider before using your retirement savings

A couple looks at real estate flyers on an agency window
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When you’re buying your first home, saving up a down payment is one of the biggest challenges. One source you can turn to is your Roth IRA. A Roth IRA is an individual retirement account you fund with after-tax dollars, then make tax-free withdrawals from in retirement. In some circumstances, you can also use up to $10,000 of your Roth IRA earnings toward a home purchase without paying taxes or penalties.

It’s important to understand the rules for using your Roth IRA to buy a home. Otherwise, you could owe taxes and fees. It’s also important to consider other factors, such as how a withdrawal will affect your retirement goals. In this article, you’ll learn how to use your Roth IRA money toward a first-time home purchase, as well as the pros and cons of doing so.

Key Takeaways

  • You can withdraw Roth IRA contributions at any time without paying taxes or penalties.
  • You can withdraw up to $10,000 of earnings while avoiding taxes and fees if you’re using the funds for a first-time home purchase.
  • The IRS will consider you a first-time homebuyer if you and your spouse haven’t owned a home that you use as your primary residence in the past two years.

How To Use Your Roth IRA To Buy a Home

While Roth IRAs are designed primarily for retirement savings, you can also withdraw up to $10,000 of your account’s earnings for a first-time home purchase. You can also use that money to build or rebuild a first home. Note that the IRS will consider you a first-time homebuyer if you and your spouse haven’t owned a home that you use as your main residence in the past two years.

However, $10,000 is a lifetime limit. If you used $7,000 of your Roth IRA earnings to buy a home in 2017, you can only use $3,000 of earnings toward your next home purchase without owing taxes or penalties.

Because a Roth IRA is funded with after-tax money, you can withdraw your contributions at any time.

Withdrawal Rules

You’ll typically owe taxes and a 10% early withdrawal penalty if you withdraw your Roth IRA earnings before reaching age 59 ½. Regardless of your age, withdrawals will be taxed if you’ve had your Roth IRA for less than five years, unless you qualify for an exception.

Distributions for a home purchase are treated differently, depending on how long you’ve had your Roth IRA. If you’re younger than age 59 ½ and:

  • You’ve held the account for less than five years: You’d pay income taxes on the earnings part of the distribution, but the 10% early withdrawal penalty wouldn’t apply.
  • You’ve held the account for five years or more: You can withdraw up to $10,000 of earnings to purchase your first home without paying income taxes or the early withdrawal penalty.

When you withdraw Roth IRA funds, the IRS will treat the money as contributions until you’ve withdrawn the full amount you’ve put into the account over the years. You’ll only withdraw up to $10,000 of earnings once you’ve already withdrawn your contributions.

Suppose you have $50,000 in your Roth IRA. Of that balance, $35,000 consists of contributions, while the remaining $15,000 is earnings. Say you want to withdraw $40,000 to help cover the down payment on your first home. Your distribution would break down as follows:

  • First, you’d withdraw the entire $35,000 of your contributions.
  • Then, you’d withdraw $5,000 of earnings.

Because you only withdrew $5,000 of earnings, you could still withdraw up to $5,000 of earnings for a future home purchase, provided you meet the IRS first-time homebuyer criteria again.

You have 120 days from the time of the distribution to use the money on IRS-approved home-related costs, such as the down payment or closing costs. At tax time, you’ll receive Form 1099-R from your brokerage that shows the amount of your Roth IRA distribution. You’ll also need to complete Form 5329 to determine whether you owe taxes, and Form 8606 to calculate how much of the distribution was from contributions versus earnings.

Instead of using this benefit to purchase your own home, you can withdraw up to $10,000 of earnings tax- and penalty-free from your Roth IRA to purchase a home for your or your spouse’s child, grandchild, or parent—as long as they qualify as a first-time homebuyer.

Pros and Cons of Using Your Roth IRA To Buy a Home

Pros
  • Extra source of funds

  • Tax-free distributions

  • Avoid early withdrawal penalties

Cons
  • Reduction in retirement funds

  • Less compounding time

  • Could result in buying too much house

Pros Explained

  • Extra source of funds: Housing prices spiked 17.5% year over year in 2021, which presents a challenge for many first-time homebuyers who don’t have cash from a previous home sale to put toward their purchase. A Roth IRA is an appealing source of funds, given its flexible rules.
  • Tax-free distributions: You can withdraw your contributions tax-free anytime. If you’ve had your Roth IRA for five years or more, you can avoid paying taxes on the distributions for a qualified first-time home purchase.
  • Avoid early withdrawal penalties: Even if it’s been less than five years since you opened your Roth IRA, you’ll avoid the 10% early withdrawal penalty if you use up to $10,000 to buy your first home.

Cons Explained

  • Reduction in retirement funds: One of the biggest downsides to using your Roth IRA for a home purchase is that you’re eating away at money you’ve saved for retirement.
  • Less compounding time: By cashing out long-term investments, you’ll give your money less time to compound—which may mean you have to save more for your retirement.
  • Could result in buying too much house: Just because you can buy a more-expensive house using Roth IRA funds doesn’t mean you should. If you need to spend Roth IRA money for a home, consider whether you could buy a smaller home by relying on your other savings.

In 2021, about 23% of first-time homebuyers used a Federal Housing Administration (FHA) loan. FHA loans have a minimum down payment of just 3.5%, which you might be able to save up without raiding your Roth IRA.

Roth vs. Traditional IRA for Homebuyers

Instead, you can use up to $10,000 of traditional IRA funds if you qualify as a first-time homebuyer. However, you don’t get the same flexibility as you would when using money from a Roth IRA.

Roth IRA Traditional IRA
Tax-free withdrawals of contributions, since they’re made with after-tax dollars WIthdrawals of contributions are taxable 
Avoid paying income taxes and 10% penalty on earnings, as long as you’ve had the account for five years Avoid 10% penalty
Five-year rule applies No five-year rule

Contribution Withdrawals

Since you fund a Roth IRA with after-tax dollars, you can withdraw your contributions without owing taxes or fees. But because traditional IRA contributions are made pretax, you’ll owe income taxes on distributions, even when you only withdraw the amount you contributed.

Taxes and Penalties

You can withdraw up to $10,000 from your traditional IRA for a first-time home purchase without paying a 10% early withdrawal penalty. However, you’ll pay income taxes on the distribution regardless of whether you’re withdrawing your contributions and earnings.

With a Roth IRA, you can avoid both taxes and penalties when withdrawing up to $10,000 of earnings to buy your first home if you’ve had the account for five years.

Five-Year Rule

To avoid paying income taxes on Roth IRA distributions of earnings, you need to meet the five-year rule, even if you’re using the money to purchase your first home. However, because traditional IRA withdrawals are taxable, no five-year rule applies.

Should You Use Your Roth IRA for Buying a Home?

When you buy your first home, you’re likely making the biggest purchase of your life. It may be tempting to take money from your Roth IRA, but you should think carefully about your financial situation before you tap into your retirement funds.

When You Should Buy a Home With a Roth IRA

You should only buy a home with your Roth IRA if you have ample retirement savings. Ideally, you’d also have access to a workplace retirement account such as a 401(k). If you’re on track to retire with more money than you need, using your Roth IRA funds to buy a home may make sense, especially if you don’t plan to retire for a couple of decades.

When You Should Not Buy a Home With a Roth IRA

Avoid using your Roth IRA for a home purchase if you’re behind on retirement savings. That may mean you need to save up longer to buy a home, but being patient is worth it so you don’t jeopardize your golden years. You should also think twice if you may need the Roth IRA for your child’s college education, given that you can also avoid the early withdrawal penalty if you use the funds to pay for higher education.

Finally, be sure you’re not stretching your budget, regardless of whether or not you’re using your Roth IRA. If you’re using retirement money for a home purchase and your monthly payments will make it hard for you to make ends meet, waiting will pay off. It’s essential that you’re able to continue saving for retirement once you’ve bought your first home.

Frequently Asked Questions (FAQs)

What counts as a first-time homebuyer for taxes and Roth IRA withdrawals?

To qualify as a first-time homebuyer for the Roth IRA early withdrawal penalty exception, you can’t have owned a principal residence during the two years prior to the home purchase. If you’re married, your spouse must meet the same requirement. The first-time homebuyer exception also has a lifetime limit of $10,000.

How does a first-time homebuyer figure out the cost basis for their Roth IRA distribution?

In a Roth IRA, your basis is the amount of contributions you’ve made over the years. To figure out your Roth IRA basis, look at how much you’ve contributed to your account each year. Check your account statements for records of your contributions. If you’re not sure, reach out to your Roth IRA custodian for help.

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