Coming up with the money for a down payment on your first home can be challenging and often requires an extended period of saving and financial sacrifice. If you've found the home of your dreams and don't want to wait, one way to obtain the necessary funds quickly is to tap into your traditional Individual Retirement Account.
A traditional IRA is a retirement vehicle where you can contribute funds on a pre-tax basis, meaning you can lower your taxable income for the tax years in which you make contributions. The level of allowable deductible contributions is determined by the Internal Revenue Service and is subject to change on an annual basis. Income earned on investments within the traditional IRA accrues on a tax-deferred basis, meaning you are not taxed on the earnings until you begin to withdraw funds.
First-time Home Purchase
In most cases, when you withdraw funds from a traditional IRA prior to reaching the age of 59 1/2, you incur an immediate 10 percent penalty and must pay taxes on the withdrawal for the tax year in which it was made. However, as of 2011, under certain circumstances the IRS permits you to withdraw up to $10,000 penalty-free as a down payment on a home . You will still owe taxes on the amount withdrawn, and you only qualify if you are a first-time home buyer or haven't owned a home within the previous two years. In addition, you must purchase the home within 120 days of making the withdrawal.
Returning the Money
The IRS recognizes that home purchases may fall through for any number of reasons, such as not being able to obtain financing or the seller failing to fulfill the terms of the sales agreement. If you are unable to complete the home purchase, you can roll the money borrowed from your traditional IRA back into the account. You will not incur penalties or be taxed on the amount as long as you return it within the 120-day time frame.
Before making an IRA withdrawal for a home purchase, there are a few points to consider. You'll need to be sure you can afford the additional tax hit on top of all the other expenses you'll incur when purchasing your home and immediately after. Consider timing your withdrawal for early in the year, if possible, so you won't have to pay any taxes until April 15 of the following year. Also keep in mind that this could leave a big hole in your retirement funds, and the money you withdraw will no longer be gaining interest. This is a better option for younger home buyers with more years to make up the difference than for those closer to retirement.