A Roth IRA Home Purchase Savings Account?

I like to read about all types of investment accounts be it a college savings plan, an IRA, 401 or any other type you can think of.  So when I opened my Roth IRA (not funded yet) I came upon an article explaining that there is a side benefit of an IRA.  You can use Roth IRA contributions to buy your first home!!!   There are strict conditions when it comes to doing this, but it can be a good way to save for a retirement and a home at the same time. 

I am not saying this would be a good idea for everyone.  If a person is in their 40s-50s I don’t think it would make as much sense (I’m not a financial expert) because your earnings potential after withdrawing a big sum of money would set you back for a while.  I suppose it all depends on how much you have in the account, but depending on how much time left until retirement it could make a dent in your retirement plans.  I do however think that if a person was in their 20’s and they decide this might work for them, it would be an awesome way to save for both at the same time. 

I will try to explain it in a simple way.  The first requirement is that you have to be a “First-Time Homebuyer”.  This is where it gets interesting.  Does that mean that because you have owned a home in the past that you don’t qualify?  Nope.  The definition of a first-time homebuyer means that you haven’t owned a home for the past two years.  A second requirement is that you must use the money to buy or build a home within 120 days of the withdrawal. 

 Now to decide which way you want to go, a Traditional IRA (tax deferred, or before taxes contribution) or a Roth IRA (income tax-free, or after tax contribution).  There are more limits going with the Traditional route than going with the Roth.  The biggest limit is that you can only withdraw $10k penalty free over your lifetime to build or buy a home.  Your spouse can also do this.  The other problem that runs with the Traditional IRA is that the withdrawal will be taxed, because when you contributed the money it was tax-deferred.  To me, that pretty much knocks that option off the table.  So lets take a look at the Roth IRA option. 

With a Roth IRA, you can withdraw your contributions any point in time (penalty and tax-free) if you need them.  Key word Contributions, not the money made from your investments, only what you contributed.  Say you maxed out  your contributions ($5000) each year for 10 years, that would be $50k that you contributed to the account.   You can take up to $10k more (which would be drawing from the earnings and not contributions), but that also has some stipulations.  One being you had to of had the account opened for 5 years or more starting from the first year you made your first contribution. If you had the account opened for more than 5 years from your first contribution, then you would pay no penalty and the $10k would be tax-free.  If the account was opened for less than 5 years, you would still be able to take the additional $10k out without the 10% early distribution tax, but the $10k earnings would be taxable at your current tax rate.  So for an account that has been opened for 10 years (and max contributed every year), you would be able to take your contributions out, $50k+$10k for a total of $60k tax and penalty free.  Keep in mind though that the additional $10k is a lifetime limit for each person for first-home purchases and cannot exceed that $10k.  Another awesome thing about this.  Your spouse can also do the same thing with his or her Roth IRA.  So after 10 years you have the potential to drop $120k as a down-payment on your new home. 

Now after 10 years if you decide owning a home is not what you want to do, you still have a pretty awesome start to retirement.  If you decide to use this as a home savings account, then even after you withdraw your contributions and the extra $10k, you still have money left in your retirement account with plenty of time to make up for the distribution you took, assuming that in those 10 years you had gains (lets hope you did).  I don’t know about you, but for me it kinda  sucks paying interest on a mortgage.  On my mortgage of $734, approximately only $250 of it goes towards the principle every month, the rest is interest at 6%.  (Although I am in the process of refinancing and lowering that rate to 3.75%)  The point is, for those that decide that this is what they want to do, you will save a crapload of money on interest paid by sacrificing some of your retirement earnings potential. Which with 30 years left until retirement, you have a chance to make that up. 

So why did I write about this when we already purchased our first home?  Because I think that it could help some people out and give them another tool to save for their home.  I wish I would have known about this prior to buying our home.  Not that it would have stopped us from buying, but it would have gave us something else to think about. 

Does this sound like it can be a good tool to use for the younger generation?  Would you consider this if you are middle-aged (40-50) ?

P.S. I am not at all a tax professional, this is just my observations and understanding from what I’ve researched.  You should always consult with your accountant and investment manager prior to making a big decision like this.   Information in this article was found at http://www.irs.gov/pub/irs-pdf/p590.pdf specifically page 51 and 62.

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