Can I Take Money Out of My Roth IRA to Buy a House?
Accessing your Roth IRA for a down payment involves specific guidelines. Learn how timing and the type of funds withdrawn affect your tax and penalty obligations.
Utilizing a Roth Individual Retirement Account (IRA) can be a way to gather funds for a down payment on a home. This retirement vehicle offers certain advantages for prospective homebuyers, but navigating the specific regulations set by the Internal Revenue Service (IRS) is necessary to avoid unexpected taxes and penalties. The rules governing these withdrawals distinguish between the money you put in and the investment gains it generates.
General Roth IRA Withdrawal Rules
A Roth IRA holds two distinct types of funds: direct contributions and investment earnings. The accessibility of each is governed by different sets of rules. Contributions can be withdrawn at any time, for any reason, without being subject to taxes or penalties. This is because you have already paid income tax on this money before it was contributed.
The rules become more complex when accessing the earnings your contributions have generated through investments. For a withdrawal of earnings to be completely tax-free and penalty-free, it must be a “qualified distribution.” A primary condition for a qualified distribution is satisfying the 5-year rule. This rule requires that five years have passed since January 1 of the tax year for which you made your very first contribution to any Roth IRA.
If you withdraw earnings before meeting the 5-year requirement and before reaching age 59½, those earnings are subject to both ordinary income tax and a 10% early withdrawal penalty.
The IRS has an ordering rule for withdrawals, meaning you are always considered to be taking out your direct contributions first. Only after you have withdrawn an amount equal to your total contributions do you begin to tap into your investment earnings.
The First-Time Homebuyer Exception
The IRS provides an exception to the standard withdrawal rules for individuals purchasing their first home. This allows for a penalty-free withdrawal of up to $10,000 in earnings. This is a lifetime limit for each individual, not per account or per home purchase. If you are married, your spouse can also withdraw up to $10,000 from their own IRA, for a potential total of $20,000 toward a home purchase.
The definition of a “first-time homebuyer” applies to anyone who has not had an ownership interest in a principal residence during the two-year period ending on the date of acquisition of the new home. This two-year look-back period also applies to a spouse, if you are married. The date of acquisition is defined as the day you enter into a binding contract to purchase the residence.
The homebuyer exception specifically waives the 10% early withdrawal penalty on up to $10,000 of earnings. It does not, however, automatically waive the income tax on those earnings. If you have met the 5-year rule, the withdrawal of earnings up to the $10,000 limit is both tax-free and penalty-free. Conversely, if you have not yet met the 5-year rule, the withdrawal is penalty-free but the earnings portion will be taxed as ordinary income.
The funds withdrawn under this exception must be used for what the IRS terms “qualified acquisition costs.” This includes the costs of buying, building, or rebuilding a principal residence for yourself, your spouse, your children, or your grandchildren. These costs can encompass the down payment, closing costs, and other expenses directly related to acquiring the property.
Tax Implications and Reporting Requirements
When you take a distribution from your Roth IRA, the financial institution acting as the custodian is required to report it to you and the IRS. You will receive a Form 1099-R, which details the gross distribution amount and the taxable portion, if any. Box 7 of this form contains a distribution code that indicates the reason for the withdrawal, which helps the IRS understand its nature.
To properly report the withdrawal on your tax return and claim the first-time homebuyer exception, you will need to file Form 5329 with your federal income tax return. This form is used to show that you meet an exception to the 10% early withdrawal penalty. Even if no tax or penalty is due, filing the form is how you officially communicate the nature of the distribution to the IRS.
If the 5-year rule is not met, withdrawing up to $10,000 of earnings for a home purchase avoids the 10% penalty, but the earnings are subject to ordinary income tax for that year. Any withdrawal of earnings that exceeds the $10,000 lifetime limit for the homebuyer exception will be subject to both income tax and the 10% penalty, unless you are over age 59½ and have met the 5-year rule.
The Withdrawal Process and Special Circumstances
To initiate a withdrawal from your Roth IRA, you must contact the custodian of your account, which is the bank or brokerage firm where the IRA is held. Each financial institution has its own specific procedures and paperwork for processing distributions. You will need to inform them that the withdrawal is intended for a first-time home purchase to ensure they code the distribution correctly on the subsequent Form 1099-R.
The funds withdrawn under the first-time homebuyer exception must be used to pay for qualified acquisition costs within 120 days of receiving the distribution.
Should the sale fall through for any reason, you have 120 days from the date you received the funds to roll them back into an IRA. Properly returning the funds within this timeframe allows you to avoid all taxes and penalties that would have otherwise applied to the distribution. This rollover is treated as if the withdrawal never happened.