In general, one is not able to purchase a home with a retirement account that they or a “disqualified person” will use. A retirement account, nevertheless, is able to invest in real estate as a passive investment but it cannot be used for any personal purpose. You do have options when using an IRA to buy a home.
- One can use his or her IRA funds to help purchase a home.
- There are tax implications on certain IRA distributions
- A 401(k) loan is another option if you have one available to you
Below are the most common options an IRA owner has when it comes to using their IRA to buy a home for personal use.
IRS rules allow one to take an IRA distribution anytime that can be used for any purpose. The IRS rules dictate that for traditional (pretax) IRAs, tax and a 10% early distribution penalty are due on any distributions taken prior to the age of 59 1/2. However, if a distribution is taken after the IRA owner reaches the age of 59 1/2, only income tax is due.
On the other hand, in the case of a Roth IRA, so long as one is over the age of 59 1/2 and any Roth IRA has been opened at least five years, then all Roth IRA distributions are tax-free. In addition, all Roth IRA contributions can be taken out at any point tax free.
Hence, a smart strategy would be to make Roth IRA contributions over a number of years and pull out the contributions if needed to buy a home tax-free and the remaining Roth funds (the appreciation on the contributions) can continue to grow tax free. This strategy allows one to save for retirement in a tax-free account as well as use the Roth contributions as a down payment for a home tax free.
The IRS allows an IRA holder to take a one-time $10,000 hardship distribution for new homeowners from an IRA. The hardship distribution is still subject to tax, but the 10% early distribution penalty will be waived. This is a smart option for someone with a pretax IRA that needs extra funds for the purchase of a home as a first-time home buyer. Note – a 401(k) plan does not include a hardship distribution option.
What is considered a “first-time home buyer?” It’s important to keep in mind that this doesn’t have to be your first home purchase. So long as it’s been at least two years since you last owned a house, you will qualify for the hardship distribution. One last thing to keep in mind is the $10,000 is a lifetime exception. Once you exhaust those funds, that’s it. For example, you can use $5,000 for a home purchase, and then use the remaining $5,000 for a future purchase (assuming you qualify).
If an IRA owner also participates in a 401(k) plan and the plan offers a Solo 401(k) loan option, the plan participant has the opportunity to borrow the lesser of $50,000 of 50% of the account value. The loan proceeds can be used for any purpose, including for the purchase of a home. The loan is generally a five-year loan where payments are due at least quarterly at an interest rate of at least Prime. That rate stands at 5.50% as of August 30, 2022. Generally, you’ll pay a point or two above the prime rate, however, that’s much better than any loan you can get at a bank. In addition, some plans allow for the loan term to be greater than five years for the purchase of a home.
You must keep up with your loan repayments. Failure to do so will lead to the distributions of the amount not repaid. Those funds will be treated as taxable income and an early distribution penalty will apply if you are younger than 59 1/2. The benefit is that you repay the loan back to your 401(k) plan, including interest. Much better than giving that money to a bank or other lender!
Using an IRA to Buy a Home
Obviously, you probably cannot outright buy a home with your IRA funds, unless you have a large balance and can afford an even larger tax bill. However, using an IRA to buy a home may be attractive for some individuals. It’s important to work with a financial planner to see how this may affect your future. Remember, any funds withdrawn from your IRA or 401(k) won’t be working for you anymore. Withdrawing funds from your retirement savings should really only be a last resort. However, if it’s your dream to be a homeowner, your IRA can help!
If you have any questions, please reach out to us @ 800.472.0646. We will be glad to explain how it works in greater detail. In fact, if you are reading this before June 22, 2021, IRA Financial President and CEO will be doing a YouTube Live all about real estate investing with retirement funds. The video will be on our YouTube channel as soon as it’s done! Check it out!