Guest post by Alanna Ritchie
Tapping into Your Retirement Savings to Buy Your First Home
After tying the knot or finding out you are expecting, there’s one great landmark left. It’s time to put down roots – so the house hunt is on.
You narrow down the choices to a few favorite places and start tearing through your finances to find enough cash for a down payment. You realize your budget is already strained.
Where are you willing to turn? Will you borrow from family, beg of friends or steal from your retirement for the joy and security of a permanent address?
With the issue of cash standing between you and the pride and security of being a homeowner, the money you’ve reserved for the future could be the key to affording present needs.
An IRA, 401(k) or annuity can provide capital, allowing you to make the big move. Depending on the type of retirement account you tap into, you will discover different benefits and sacrifices.
Some plans offer tax advantages to first-time home buyers and some do not require you to repay the money you remove. Whichever account you use, you will lose some of the future value of your retirement savings. Evaluate your assets and priorities carefully before you decide which one to pursue.
Qualifying for a Hardship Withdrawal
The IRS allows an exception to some tax rules for first-time home buyers. Owners of IRAs and 401(k)s may qualify for a hardship withdrawals when buying their first home.
Eligible withdrawals are exempt from the 10 percent tax penalty for using retirement funds before 59 ½. You will be required to use the funds within 120 days and have the option of putting the money toward rebuilding a home, buying a home or paying settlement, financing or closing costs.
Do You Have a Traditional or Roth IRA?
You can use up to $10,000 of traditional IRA funds for your new home. If you are married, both you and your spouse can contribute, giving you a $20,000 boost.
For a Roth IRA, you can take out the same amount as long as you’ve had the account for five years. If you opened the Roth IRA earlier, you can still avoid the 10 percent penalty for early distribution, but you may be liable for taxes on earnings.
Have You Been Contributing to a 401(k)?
To utilize funds from your 401(k) for a home down payment, take out a loan against your plan rather making a straight withdrawal. You can borrow up to half of your vested balance or $50,000—whichever is less—without taxes and penalties. When you make payments on this loan, generally your company will ask for an automatic monthly deduction from your paycheck. Many financial advisors do not favor borrowing against retirement funds to pay for things like a house, car or luxury item because they believe too many people end up not paying themselves back and cost themselves an early withdrawal penalty.
Some companies place conditions on these loans. For instance, if you leave the company, you may have to repay the balance of your loan with 30 or 90 days of your last day or else face fees or penalties. If the amount of money you borrow from yourself is substantial, your long-term stability at your job is something to consider.
If you’ve already used your 401(k) allotment, you can take a hardship withdrawal for a home purchase (provided your employer allows it), but you will be responsible for taxes and penalties. Because this is a home purchase, you may be able to set up a repayment plan for 15 years.
Do You Own an Annuity?
If you own one or more annuities or structured settlements, you may be able to sell payments for a discounted rate. However, because annuities are not primarily growth investments, you sacrifice less of an opportunity cost when you utilize these funds ahead of schedule.
If you sell payments scheduled to go to you in the near future, you can get a higher price for those payments than if you sell payments scheduled to come to you year from now. Estimate the monthly income from your Social Security payments and other savings to ensure you will still be able to handle living expenses during retirement.
Pay Attention to the Details
As you decide how to finance your down payment, pay attention to the details and consult a tax professional who understands the complexities of IRAs, annuities and company retirement contracts. This one step alone could save you thousands of dollars.
Keep in mind that taking money from certain accounts will be viewed as income during tax time, possibly bumping you into a higher tax bracket than the previous year.
Good news can also be hidden in the fine print. For example, the IRS rule that allows hardship withdrawals for first-time home buyers extends to include those who have not owned a home in the past two years.
As you and your family contemplate where you plan to grow old together, stay on the look-out for financial resources that go beyond your current income and bank account. You may discover a way to buy your new home sooner rather than later.
Alanna Ritchie has spent years studying, writing and learning to love the intricacies of the English language. Today, she works as a content writer for Annuity.org, where her primary focus is personal wealth management.