Should I Use My Retirement Savings for a Home’s Down Payment?
Current low-interest mortgage rates have some of us considering the purchase of a home rather than renting. Rents have gone up, and home costs are fairly stable. For some, the cost of ownership might seem less than costs to rent. Let’s dive into this a bit.
Cash liquidity for a downpayment is a key to a real estate purchase. Do you have that liquidity or can you dip into your retirement nest egg for the down payment?
Retirement savings are meant to provide income and finance your retirement. If you take some retirement savings for a real estate down payment you may be jeopardizing financial security upon retirement. If you make withdrawals before your retirement age, you will also incur significant penalties and taxes.
That said, not all situations are the same. There are individual situations when it can actually be reasonable to use your retirement savings for your home purchases.
Using distributions from pre-tax retirement accounts such as a traditional IRA or 401 (k) are generally not recommended. Distributions will be treated as normal income and taxed accordingly. This might include a 35% federal tax rate, a plethora of state taxes along with federal penalties. So in the end, you might end up incurring a bigger tax burden while at the same time reducing your retirement nest egg.
Rather than dipping into retirement, many first-time homebuyer programs and grants offer financial help, and you may be eligible for various types of assistance. These include FHA loans, USDA Homebuyer Assistance Program, VA Loans, Good Neighbor Next Door program sponsored by HUD, Fannie Mae or Freddie Mac loans, Energy-efficient mortgage (EEM), FHA Section 203(k), Native American Veteran Direct Loan and local grants and programs provided via states and cities. Do your due diligence and see what’s available to help reduce your costs.
When Might it be Prudent to Use Your Retirement Savings for a Down Payment for your Home?
There are instances where withdrawing from a retirement account such as a traditional IRA can make financial sense. As a first time home buyer, you can make limited withdrawals from your traditional IRA account in order to finance your first-time home purchase.
As a first time homebuyer, you are permitted by law to take up to $10,000 from your traditional IRA account without incurring the 10% early withdrawal penalty. This is applicable on the condition that you use the withdrawn funds for a home purchase within 120 days.
However, it is important to keep in mind that this limited withdrawal is tax-deductible and will be taxed. To make the most of mortgage-interest deductions for that year, you might consider timing your home purchase and traditional IRA withdrawals early in the year. If the home purchase does not go through, you can still avoid penalties and taxes by rolling back the withdrawal to your traditional IRA account. The IRA rollover must be done with within 60 days. Ensure you familiarize yourself with the IRA rollover rules and regulations in order to avoid costly federal and state taxes and penalties.
Using a ROTH IRA to For Your Home Down Payment
You can also your finance your home down payment using your ROTH IRA. These contributions aren’t tax-deductible so you can make withdrawals without incurring any penalties or taxes. Unlike traditional IRA, ROTH IRA gives you a great deal of flexibility and this is one of the top reasons why it is a top choice for retirement savings for people who want to save for retirement but need a little flexibility in the future. On the flipside, by using your ROTH IRA account, you are depleting a retirement savings arsenal that is immune to future tax increments.
Financing Your Home with a 401 (k)
Most Certified Financial Planners® will advise that your 401(k) should be a sacrosanct retirement nest egg; your future iron rice bowl that you avoid touching under any circumstances. Instead, you might want to consider taking out a loan on your 401 (k) account to finance your home purchase. It is possible to borrow up to 50% of your vested balance in your 401(k) without incurring taxes and penalties.
In the event this option isn’t enough, or not a good solution, you are also permitted to make a “hardship” withdrawal of funds from your 401 (k) account if you are planning to use the funds to buy or keep a primary home. However, this comes with some penalties and taxes. In addition to a 10% penalty, the withdrawal will also be subject to regular income taxes. Making a “hardship” withdrawal will also bar you from making contributions to your 401(k) account for 6 months. There is one final caveat: while taking loans on your 401(k) account and making “hardship” withdrawals is permitted by law, they are subject to approval by your employer and they (your employer) may choose to limit the withdrawals and loans.
Admittedly, these are difficult choices. Financing a down payment with retirement savings isn’t for everyone and it is advisable to talk to a financial advisor to help you look at your options before taking the plunge. For more information on this and other retirement and wealth management issues, contact us today!