Today the PF blogosphere will start a movement to educate people on the awesomeness that is the Roth IRA. This movement, led by Jeff Rose over at Good Financial Cents, the peeps that run RothIRA.com, IRA Market and 140+ other bloggers like myself want you to know how sweet a Roth IRA can be. The following article is one of the reasons why I think you should open a Roth IRA.
I like to read about all types of investment accounts, from college savings plans (I don’t even have kids yet), to IRA’s, 401k’s and individual accounts. When I was researching where to open a Roth IRA I came across an article explaining some benefits of IRA’s, both Traditional and Roth’s. One of the side benefits of Roth IRA’s is that You Can Use Roth IRA Contributions to Buy Your First Home!!!! There are some strict conditions to this, but it can be a good way to save for retirement and a home at the same time.
I’m not saying this would be a good idea for everybody. This doesn’t make as much sense to me if a person in their 40’s and 50’s were to do this. Withdrawing such a large amount this late in the game could reduce your earnings potential to a point where it wouldn’t make it financially beneficial for you to do so. I suppose it depends also on how much you have in your account and how much time you have left until retirement. Being later in the game it could make a dent in your retirement plans. I do however think that if a person was in their 20’s or early 30’s and they decide to do this it could be an awesome way to kill two birds with one stone.
I will try to explain it in a simple way. The first requirement is that you have to be a “First-time Homebuyer.” Does that mean that because you have owned a home in the past that you are disqualified for this? Nope. To be qualified as a “First-time Homebuyer” you couldn’t have owned a house during 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.
You can do this with both a Traditional IRA (tax deferred and pre-tax contributions) and a Roth IRA (tax-free and after-tax contributions). There are more limits going the Traditional route than going with the Roth. The biggest limit is that you can only withdraw $10k penalty free over your lifetime from a Traditional IRA to build or purchase a home. This can be done by your spouse also. The other problem that runs with the Traditional is that the withdrawal will be taxed, because your contributions are pre-tax dollars. To me that pretty much knocks that option off the table. Lets take a look at the Roth IRA option.
With a Roth IRA you can withdraw your contributions at any point in time (penalty and tax-free) if you need them. The key word here is Contributions, not the money you hopefully made from your investments. As of today a person under the age of 50 can contribute a maximum of $5k into a Roth IRA each year. Say you maxed out your contributions each year for 10 years, you would have contributed $50k into your Roth. You are able to pull that money (your contributions) out for any reason because it was all after tax money. You can also withdraw up to $10k more (which would be drawing from your earnings, assuming you had earnings) but this also has stipulations to it. One being that the account had to have been open for 5 years or more from the date of your first contribution. If you meet this requirement the $10k would be tax and penalty free. If the account has been open for less than 5 years, you can still withdraw the extra $10k without the early 10% distribution tax, but the $10k would be taxed at your current tax rate. The extra $10k is a lifetime limit per person and once you have used that limit up its done. For an account that has been open for 10 years (maxed-out contributions) you would be able to withdraw a total of $60k ($50k in contributions and $10k of earnings) tax and penalty free. Your spouse could also do this with his/her Roth IRA, so if both of you have been maxing out your Roth IRA contributions there is potential to have $120k towards building or purchasing your first home.
If after 10 years you decide that owning a home is not what you want to do, then you have an awesome start to a retirement account. If you decide you want to use a Roth IRA as a home purchase account and withdraw money later on for that reason, you still have whatever you earned in those 10 years in your Roth IRA, with plenty of time to make up for the money you are withdrawing for a home purchase.
I don’t know about you, but I hate seeing how much of my mortgage payment goes towards interest and not the principle. The point of this for those that decide to use Roth contributions towards purchasing a home, is that you could potentially save a boatload of money on interest by sacrificing some of your early earnings potential in your retirement account. If you do this by age 30, you still have 30 years left to make up for it. You should take account of what the interest rates are at and what your returns are in your Roth. It might not make financial sense to do this when interest rates are so low. Unless you really hate debt like I do. I purchased my home before I got into investing, not saying that we wouldn’t have bought our home if we would have known about this option, but it would have given us something to think about. Either way, contributing to a Roth is a win-win for you.
What do you think, could this be a good tool to use for the younger generation to save for a home?
P.S. I am not at all a tax or real estate professional. This is just my observations and understanding from what I’ve researched. You should always consult with a tax professional and your investment manager prior to making decisions like this. Information in this article was found here specifically pages 51 and 62. Always research and read the fine print before making your decision.