What's the deal with using my IRA to buy a home?

A first time home buyer might be lured to use IRA savings to defray the costs of the down payment and closing.    Before doing so, think about the tax consequences.  An exception exists to that 10% tax penalty that normally applies to all early withdrawals of IRA money.  However, there is no tax forgiveness.  That means that the income still must be added to your tax return and will be taxed.   If a taxpayer is in the 25% tax bracket, the federal and MA state tax consequences total $3,000.   In other words, only $7,000 is the after tax benefit of cashing out $10,000.  The exception is limited to $10,000.   This means that any amount over $10,000 is also subject to that 10% penalty.

Note that this exception to the 10% early penalty only applies IRA’s.   A withdrawal from your 401k or other qualified pension plan will incur the federal $1,000 penalty.   However, to purchase your first home using 401K money, you might be able to may loan yourself up to 50% of your 401k balance, or up to $50,000.  Typical 401k loans must be paid back in five years.   First time home buyers are allowed a fifteen year payback period.

Before you draw money from your IRA to purchase that new home, talk to your financial advisor.   There may be better options.

Note that the IRS allows a taxpayer to exercise this once in a lifetime.  Also note that the IRS allows a taxpayer to draw money for a child’s first home or a grandparent’s first home.  Lastly, the definition of a first time homebuyer is someone who has not owned a home for at least two years.  But before you do anything, explore all options.