Can You Take Money Out of Retirement to Buy a House?

Using funds from a retirement account to purchase a home is a possibility many consider, particularly when facing significant upfront homeownership costs. While this strategy can provide capital, it involves specific rules and financial implications. Understanding these nuances is important for anyone considering such a move.

General Rules for Retirement Account Withdrawals

Retirement accounts are designed for future savings and long-term growth. Most plans, such as traditional Individual Retirement Arrangements (IRAs) and 401(k)s, allow penalty-free withdrawals only after age 59½. Taking money out before this age typically incurs a 10% early withdrawal penalty on the amount withdrawn, in addition to any income taxes owed.

When funds are withdrawn from pre-tax retirement accounts (e.g., traditional IRAs or 401(k)s), distributions are generally taxed as ordinary income in the year received. Roth accounts operate differently; contributions are made with after-tax dollars. Qualified distributions from a Roth IRA are typically tax-free and penalty-free. To be qualified, Roth distributions generally require the account to have been open for at least five tax years and the account holder to be age 59½ or older, or meet specific exceptions.

Specific Rules for Home Purchase Withdrawals

A specific exception allows individuals to withdraw funds from certain retirement accounts for a first-time home purchase without the 10% early withdrawal penalty. This exception applies to Individual Retirement Arrangements (IRAs), including Traditional and Roth IRAs. It generally does not extend to 401(k) plans for direct penalty-free withdrawals, though 401(k)s may offer loans or hardship withdrawals under different rules.

To qualify for this exception, the individual must meet the Internal Revenue Service (IRS) definition of a “first-time homebuyer.” This means the individual, and their spouse if married, cannot have owned a principal residence during the two-year period ending on the new home’s acquisition date. The maximum amount that can be withdrawn penalty-free under this exception is $10,000, a lifetime limit per individual. If a married couple both qualify and each has their own IRA, they can each withdraw up to $10,000, totaling $20,000, for the same home purchase.

Funds withdrawn under this exception must be used to pay qualified acquisition costs for a principal residence. These costs include expenses for buying, building, or rebuilding a home, as well as usual settlement or closing costs. The funds must be used within 120 days of the withdrawal date. This exception can also apply if the funds are used for a qualified first home of a spouse, child, grandchild, or parent.

Calculating Tax Liability and Penalties

Even when an exception waives the 10% early withdrawal penalty, the withdrawn amount from pre-tax retirement accounts, such as traditional IRAs, is generally still subject to federal income tax. This means the distribution is added to the individual’s gross income for the year and taxed at their ordinary income tax rate. The tax liability depends on the individual’s income bracket for that tax year.

If a withdrawal does not meet a qualified exception, the 10% early withdrawal penalty will apply in addition to regular income taxes. For example, if $10,000 is withdrawn from a traditional IRA without qualifying for an exception, a $1,000 penalty would be assessed, along with applicable income tax. This can significantly reduce the money available for the home purchase.

Roth IRA withdrawals offer different tax treatment for qualified distributions. If the Roth IRA has been open for at least five years and the distribution is for a qualified reason, such as a first-time home purchase, the withdrawal is generally both tax-free and penalty-free. This includes both contributions and earnings. However, if the Roth IRA’s five-year holding period has not been met, earnings withdrawn may be subject to taxes and penalties, even if the penalty is waived for the first-time homebuyer exception.

Executing a Retirement Account Withdrawal

To initiate a withdrawal from a retirement account, contact the custodian or plan administrator. They manage the account and provide necessary forms and guidance for a distribution.

These forms require details such as the amount to be withdrawn, the reason for the distribution, and how the funds should be disbursed. Funds can usually be received via check or direct deposit into a linked bank account. Once submitted, the timeline for receiving funds can vary, typically ranging from a few days to a couple of weeks.

For tax reporting, the retirement account custodian will issue IRS Form 1099-R, detailing the distribution amount and any taxes withheld. If claiming an exception to the early withdrawal penalty, such as the first-time homebuyer exception, individuals may need to file IRS Form 5329, “Additional Taxes on Qualified Retirement Plans (Including IRAs) and Other Tax-Favored Accounts,” with their tax return. This form allows taxpayers to report the exception and avoid the penalty.