A Roth IRA could help you buy a home. Here is what you need to know
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For some potential homeowners, finding the money to buy a home can be tricky.
Depending on your situation, a Roth Individual Retirement Account might help.
In a nutshell, up to $ 10,000 in Roth IRA income can be withdrawn – without tax or penalty – towards the purchase of a home if you meet certain conditions. This is in addition to being able to withdraw your direct contributions at any time because you have already paid taxes on that money.
As home prices continue to rise in a tight real estate market, so does the amount of money needed to buy one.
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While it’s possible to buy a home with less than 20% down – the average is 12% overall and 6% for first-time buyers – going this route can also mean paying for insurance. private mortgage, or PMI, until your principal is at least 20% of the value of the home. PMI can run $ 30 to $ 70 per month for every $ 100,000 borrowed, according to Freddie Mac.
For a $ 250,000 home, a 6% down payment would be $ 15,000. At 20%, that would be $ 50,000. These amounts do not include other costs associated with the purchase, such as transfer duties or points, which 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 rate for a 30-year conventional mortgage is around 3%, according to Bankrate.com.
However, using Roth IRA money to buy a home is not a strategy that makes sense for everyone. Here’s what to consider.
Roth Ground Rules
Roth IRA contributions are made after tax. This means that you can withdraw this money at any time without penalty. The contribution limit for 2021 is $ 6,000 ($ 7,000 for people aged 50 or over).
However, to make contributions, your modified adjusted gross income cannot be more than a fixed amount. To contribute the maximum, the income limit is $ 125,000 if your tax filing status is single and $ 198,000 for married couples who file jointly. Above these income amounts, the contribution limit is reduced until it is completely eliminated to income of $ 140,000 for single filers and $ 208,000 for co-filers.
While these contributions are yours when you want them, the same can’t be said for the growth of the account. Unless you encounter an exclusion – such as turning 59 and a half and having owned a Roth IRA for at least five years – the income withdrawal will generate taxes and a 10% penalty.
For eligible first-time home purchases, this 10% penalty is waived. However, to avoid income taxes, you must have held the Roth IRA for at least five years (with a few exceptions related to the contribution schedule).
For Roth conversions – that is, money transferred to a Roth IRA from another retirement account – you typically have to sit there for five years if you’re under 59 and a half to avoid the 10% penalty on any withdrawal (unless you complete the first-time-home-buyer exclusion).
The main problem
The exclusion applies to first-time home buyers or people who have not owned a home as their primary residence for at least two years. The buyer can be you, your spouse or a member of your family.
The withdrawal must also be used within 120 days of distribution and be used to pay for expenses directly related to the purchase of the home, such as a down payment or other closing costs. And the $ 10,000 exclusion is a lifetime limit.
Be aware that traditional IRAs also come with the penalty-free exclusion for qualifying home purchases. However, the $ 10,000 limit is applied to the entire withdrawal, said chartered financial planner and CPA Jeffrey Levine, planning director of Buckingham Wealth Partners in Long Island, New York. And you would generally pay taxes on the money.
Setting up a Roth IRA to buy a home
The flexibility of a Roth could make it a good place to save and buy a house later, some advisers say.
“We have long suggested that young people use a Roth IRA to save the massive amount needed for a first-time home purchase,” said CFP Daniel Galli, director of Daniel J. Galli & Associates in Norwell, Massachusetts.
“As long as we can stick to the five-year rule, they can use all contributions plus up to $ 10,000 in earnings, with no tax or penalty,” Galli said.
However, he said he recommended the strategy to young workers who are also saving for retirement through a 401 (k) plan at work.
Plus, Galli said, there can be risks, depending on how aggressively you invest the money in the Roth IRA.
“This strategy requires some market risk in order to enjoy some of the gains, but the rewards can balance that out,” said Galli.
If you go this route, the level of risk you should take in your portfolio depends in part on how long until you need the money, said Levine of Buckingham Wealth Partners. If you plan something 10 years from now, he says, you could start aggressively investing in stocks and gradually reducing your exposure.
“You might want to make it more conservative over time,” Levine said.
Use existing Roth money
If you already have money in a Roth IRA and are now considering financing the purchase of a home, be aware that many financial advisors caution against using that money if it was intended for the home. retirement.
“These accounts are designed to help people accumulate as much money as possible for their retirement,” said CFP Shon Anderson, president of Anderson Financial Strategies in Dayton, Ohio.
“You can get a loan for a house, a car, a business, a tuition fee… but no one will ever get a loan to retire,” Anderson said.
However, depending on your situation – that is, how much you would withdraw, if you have sufficient retirement savings elsewhere, if you can otherwise afford the house payments and homeownership fees – use Roth money for a house might make sense.
“If the person contributes to a 401 (k), getting a decent game, they’re on a good retirement path and the Roth is just a nice addition, I might consider that,” Galli said.
“But if their only retirement savings is the Roth and they’re, say, in their 40s, I probably wouldn’t,” he said.