A Roth IRA could help you buy a home. Here’s what to know

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For some aspiring homeowners, finding the money to buy a home can be difficult.

Depending on your situation, an individual Roth retirement account can be helpful.

In short, up to $ 10,000 in Roth IRA earnings can be deducted – excluding taxes and penalties – for a home purchase if you meet certain requirements. That is in addition to the fact that you can withdraw your direct contributions at any time since you have already paid tax on that money.

As property prices continue to rise in a tight real estate market, the amount of cash needed to purchase one also increases.

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While it is possible to buy a home with less than 20% decline – the average is 12% overall and 6% for first-time home buyers – that avenue can also mean paying private mortgage insurance (PMI) up your equity at least 20% of the house value. According to Freddie Mac, the PMI can range from $ 30 to $ 70 per month for every $ 100,000 borrowed.

For a $ 250,000 home, a 6% down payment would be $ 15,000. At 20% it would be $ 50,000. These amounts do not include any other costs associated with the purchase, such as: B. Transfer taxes or points that generally lower the interest rate on the loan. (One point equals 1% of the mortgage).

At the same time, the cost of borrowing is relatively cheap due to the low interest rates. The average interest rate on a traditional 30 year mortgage is around 3%, according to Bankrate.com.

Still, using Roth IRA money to buy a home is not a strategy that makes sense for everyone. Please note the following.

Basic rules of Roth

Roth IRA contributions are paid after taxes. This means that you can withdraw this money at any time with no penalty. The contribution limit for 2021 is $ 6,000 ($ 7,000 for people aged 50 and over).

However, in order to make any contributions at all, your modified adjusted gross income must not exceed a specified amount. To contribute the maximum, the income cap is $ 125,000 if your tax return status is single and $ 198,000 for married couples filing together. Above these amounts of income, the contribution limit will be decreased until the income of $ 140,000 for individual taxpayers and $ 208,000 for joint taxpayers expires.

While these contributions are yours whenever you want them, it cannot be said for an account growth. If you don’t come across an exclusion, e.g. B. Reaching the age of 59 and having owned a Roth IRA for at least five years, withdrawing income leads to taxes and a 10% penalty.

This 10% penalty does not apply to qualified first-time home purchases. However, to avoid taxes on income, you must have held the Roth IRA for at least five years (with some exceptions related to timing of contributions).

With Roth conversions – that is, money transferred from another retirement account to a Roth IRA – you typically have to sit on it for five years if you are under 59½ years old to avoid the 10% withdrawal penalty (unless you meet the first – Time Home Buyer Exclusion).

The essentials

The exclusion applies to first-time buyers or people who have not had a house as their main residence for at least two years. The buyer can be you, your spouse, or one of your family members.

The payout must also be used within 120 days of being distributed and used to pay for expenses directly related to the purchase of a home, such as living expenses. B. a down payment or other closing costs. The exclusion of $ 10,000 income is a lifetime limit.

As long as we can adhere to the five-year rule, all contributions plus a profit of up to $ 10,000 are free of tax and penalties.

Daniel Galli

Director of Daniel J. Galli & Associates

Note that traditional IRAs also include the impunity exclusion for qualified home purchases. However, the $ 10,000 limit applies to the entire payout, according to certified financial planner and CPA Jeffrey Levine, chief planning officer of Buckingham Wealth Partners in Long Island, New York. And you would generally be paying taxes on the money.

Setting up a Roth IRA for a home purchase

A Roth’s flexibility could make it a good place to save money to buy a home later, some consultants say.

“We have long suggested that young people use a Roth IRA to save the substantial amount needed on a first-time home purchase,” said CFP Daniel Galli, director of Daniel J. Galli & Associates in Norwell, Massachusetts.

“As long as we can adhere to the five-year rule, you can use all contributions plus a profit of up to $ 10,000 tax and penalty free,” said Galli.

However, he said he recommended this strategy to young workers who are also saving on work for retirement through a 401 (k) plan.

Additionally, Galli said, there may be a risk depending on how aggressively you are investing the money in the Roth IRA.

“This strategy requires some market risk to make some profits, but the rewards can make up for that,” Galli said.

If you go down this route, the risk you should take on your portfolio will depend in part on how long it will be before you need the money, said Buckingham Wealth Partners’ Levine. If your plan was 10 years, you could start investing aggressively in stocks and gradually reduce your exposure.

“Maybe over time you want to make it more conservative,” Levine said.

Use existing Roth money

If you already have money in a Roth IRA and are now considering it as a way to finance a home purchase, be aware that many financial advisors caution against using that money if it is earmarked for retirement.

“These accounts are designed to help people raise as much money as possible for retirement,” said CFP Shon Anderson, president of Anderson Financial Strategies in Dayton, Ohio.

“You can get a loan on a home, a car, a business, a tuition … but no one is ever going to get a retirement loan,” said Anderson.

Depending on your situation – that is, how much you would withdraw, whether you have adequate retirement provisions elsewhere, whether you can otherwise afford the house payments and the cost of owning a home – it may make sense to use the Roth money on a house.

“If the person contributes to a 401 (k) and scores a decent match, they are well on their way to retirement and the Roth is just a nice addition I might consider,” said Galli.

“But if their only retirement plan is the Roth and they are in their forties, for example, I probably wouldn’t,” he said.

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