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Using a Roth IRA to Help Buy a House

Roth IRA to buy a house
4 Minute Read

Are you looking to buy your first house? Maybe you are in a position to buy a vacation retreat. Or, maybe you are thinking about how you can put away money to buy your dream home. Look no further than your retirement savings. You can actually use a Roth IRA to buy a house. Not only do you get the tax advantages of the plan, but you can use your contributions to the plan at any time and for any reason. There is no taxes and you don’t face a penalty. We explain how the Roth IRA works and how you can own your own piece of real estate.

Key Points
  • A Roth IRA is a unique way to save for retirement
  • Contributions can be withdrawn at any time tax- and penalty-free
  • Use your savings to help buy your own house

The Roth IRA Advantage

In case you are unaware of this popular retirement account, let’s get over the basics. Unlike a traditional IRA, a Roth allows you to save after-tax money for retirement. There is no upfront tax-break (since you have already paid taxes), however, all qualified Roth distributions are tax free. There are no annual taxes for your retirement plan. If you can leave the funds in the plan until you reach age 59 1/2, and any Roth IRA you have has been owned for at least five years, you never pay taxes.

In an ideal world, we would never have to dip into our retirement savings. But not every American’s financial situation is perfect. There are times you don’t have a choice but to withdraw money that’s been earmarked for your golden years. When distributing funds from a traditional plan, anything you take out will be treated as taxable income. Plus, if you are under age 59 1/2, you will generally be hit with a 10% early withdrawal penalty. All that hard work saving for retirement and much gets wasted in taxes and penalties.

How the Plan Works

That’s where the Roth IRA comes into play. Since contributions are made with previously-taxed money, they can be withdrawn from the plan whenever you need them. The IRS has gotten their cut already, they will never tax that money again. You mustn’t confuse contributions with earnings or even conversions. There’s a big difference.

Only your contributions have been taxed; earnings have not. To take full advantage of the Roth IRA, those must remain in the plan until you can make qualified distributions. Otherwise, they will be taxable and penalties will apply.

For example, you contribute $10,000 to a Roth IRA and after two years, it is now worth $15,000. The $10k in contributions can be withdrawn at anytime. However, if you withdraw any or all of the earnings, it will be treated as taxable income. You can withdrawn the $10,000 for personal use, and leave the $5,000 in earnings to continue to grow tax free.

Using a Roth IRA to Buy a House

Now that you know how the Roth IRA works, it’s time to use those funds to buy a house. It’s important to keep in mind that this strategy should only be used is needed. If at all possible, you want your retirement funds to remain untouched until you actually retire. However, using a Roth IRA to save gives you the flexibility to pull funds from the plan if needed.

As explained earlier, your direct Roth IRA contributions can be withdrawn tax- and penalty-free. Not only can you use those funds for a down payment on a house, you can use them for emergencies as well. It’s a great vehicle (as opposed to a savings account) to save for an emergency. The interest you earn from savings account is usually not enough to even keep up with inflation.

Why not save with a Roth IRA, invest your money, and see far greater returns. Yes, there is some risk when investing. However, over the long run, even safe investments in the stock market will see much better returns. And thanks to the power of compounding, the more money you accumulate in your IRA, the faster it adds up.

An Example

In the video above, IRA Financial’s Adam Bergman gives a great example of how saving just a few dollars a day can add up. If you start saving just $3 per day at age 22, and earn an 8% rate of return, your Roth IRA will be worth over $680,000 by the time you reach age 72. Using those same numbers, by age 35, you will have contributed about $14,000, plus around $11,000 in earnings.

You can withdraw that $14,000, and use that to help with a down payment on your new house. The $11,000 will remain in the plan, and continue to grow on a tax-free basis. Obviously, if you withdraw from the plan, you will not reach that $680,000 number, unless you start contributing more. You should explore all other options before distributing funds from the Roth.

You Can Self-Direct Your Roth

Lastly, if you chose the Roth IRA route, you can always self-direct the plan. This means you can invest in virtually anything you want with your retirement funds. This allows you to diversify your holdings, invest in alternative assets, like real estate and precious metals, and, hopefully, see a better rate of return than you get when you are forced into traditional investments only.

The only things you cannot invest in with an IRA, as per the IRS, are collectibles, life insurance, and any transaction that involves a disqualified person, or other prohibited transaction. Essentially, so long as the plan is the only entity that is benefiting from the IRA investment, you are good. For example, you cannot buy a vacation property with a Roth IRA and then stay there yourself. You are then benefiting from the investment.

The Self-Directed Roth IRA is something to consider if you are looking at using a Roth IRA to buy a house. That way, your savings will (hopefully) grow faster than with a plan opened at a local bank or other financial institution. They won’t let you invest in alternatives, and you’ll be stuck with a small menu of option.

Conclusion

Using a Roth IRA to buy a house is just one reason to save in this unique retirement plan. It’s important to keep in mind, that while you are allowed to withdraw from the plan, that doesn’t mean you should. Every situation is unique so speak with a financial advisor if it’s worth it. Someone with a million dollars across retirement accounts is better off than one with $20,000.

Owning a home is many Americans’ dream. If utilizing some retirement savings to help accomplish this, then it may be worth looking into. Beware of the consequences of withdrawing retirement funds and make sure it won’t hurt you too much in the long run.

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