Can You Tap From Your IRA/ 401k In Buying Your First Home?
By Eliseo "Jojo" Prisno, CRPC, MS
Chartered Retirement Planning Counselor
PE CAPITAL INVESTMENTS
This question was emailed to me through our website a few weeks back. It is quite a common question from home buyers, especially those that had built up retirement savings either through an individual plan (IRA) or employment sponsored program like a 401k.
The straight answer is YES, you can use your IRA savings or borrow from your 401k plan or 403b for that matter. What are the rules? The rules are pretty simple-- first is the property to be bought should be a primary home, meaning you will be living in it. If you are single you may use your IRA savings to establish the down payment, however it is capped up to $10,000. If you are married, both of you can tap up to $20,000, that is $10,000 in each IRA (these type of accounts are individuals and not shared by spouses). The distribution will still be taxable (added to your gross income for the year);however, it is free from the 10% early withdrawal penalty. Note that IRAs (individual retirement accounts) are designed for retirement savings and the earliest withdrawal is when you reach 59 ½ years old. Any withdrawal outside of the exemptions before 59 ½ is subject to a 10% penalty, that is 10% on top of the pegged taxes. For example if your tax bracket is at 20%, you will end up paying 30% (20% + 10%) of early distribution.
Distribution Exemptions (Early Withdrawal Without Penalty):
What are early withdrawal exemptions in an IRA free of the 10% penalty? The most common is buying your first home or primary home and second is when you use your IRA for tertiary education or paying college tuition fees and expenses. The third exemption is when you have a major medical issue (either yourself or other immediate family members) or paying medical bills. If your distribution falls under the stated reasons, then there is no 10% penalty however it will still be taxable. What if the withdrawal is from a Roth IRA?
Using Your Roth IRA Savings Before 59 ½:
Note that Roth IRA’s are after tax savings, meaning you did not avail a tax deduction on your contributions (by the way the current contribution cap if you are below 50 years old is $5,500 per year on Tradition IRA and Roth IRA, once you reach 50 years old, you can add $1,000 as catch up contribution). Thus, if you want to use your Roth IRA money to buy your primary home, the distribution is tax free and of course penalty free as well. Also, if your Roth IRA savings has been invested by at least 5 years, the growth portion of your Roth IRA will also be tax free. Roth IRA’s however, are discriminatory, meaning not everyone can contribute to it. If you are a single filer with an adjusted gross income of less than $117,000 you are qualified to contribute, for joint filers (married couples); the AGI must be less than $184,000. These are the 2016 eligibility numbers.
Tapping From 401K’s (or 403b’s):
If you have a 401K plan, you can borrow from it. Normally, for first home purchase, you may borrow up to 50% of your 401K plan (that includes your employer contributions or the matching) up to a maximum of $50,000. And since this is in form of a loan, there is no distribution income tax or an early withdrawal penalty. However, just like any other loans, you have to pay it back with interests (typically prime rate plus 1 or 2 percentage points). In most cases you have to repay the loan in 5 years but for home purchase, the time frame maybe extended up to 15 years. Note that your 401K contributions will now be deducted with the cost of money and the principal reduction, the difference or extra will cover your contribution. This distribution will be the basis for employer matching.
Which is the best route: IRA or 401K?
I normally advise borrowing from your 401K. The reason is simple, there is a form of discipline and there is no income tax (except for Roth IRA). If you use your IRA, you are not obligated to return the used money to the account. Borrowing from your 401K requires repayment thus you continue building your retirement savings. Note that you borrowed from your own money and the repayment of it means you are rebuilding it back. The only loophole here is to make sure you increase your contributions because a portion of it will be used for repayment. If the excess after principal and interest payment is still enough to get your maximum employer matching, then you are still fine. However, if it is not enough to maximize the employer matching, then you have to add up. You should not miss any free monies in your retirement savings.
Please feel free to post questions on our website or Facebook page if you have other financial inquiries. I will try to diligently answer them in my monthly article. For any financial questions, always ask financial professionals for answers.
ABOUT THE WRITER: Eliseo Jojo Prisno is a Chartered Retirement Planning Counselor (CRPC).He founded P/E Capital Investments in 2010, a State Registered Investment Advisory Firm (CRD# 172695) and is currently the firm’s Managing Director and Senior Investment Advisor. Mr. Prisno also manages a Fund of Funds investment program with Ameritas and runs an All-Equity Growth and Income customized portfolios in separate accounts via E*Trade Securities. If you have questions email j.prisno@PEcapitalinvestments.com or call 1-888-929-2825. Visit our website www.PEcapitalinvestments.com