One of the biggest challenges to get down the road for many potential homebuyers is the initial cost.
On the low end, you’ll typically need no less than 3% to 5% for a down payment and an additional 3% to 5% for closing costs like insurance, prepaid taxes, and lender fees. As home prices skyrocket, so does the amount you should have saved. He median home sales price Now it’s over $500,000, which means a typical buyer will typically need at least $50,000 set aside for a home purchase.
For those lucky enough to have significant retirement savings in a 401(k) or individual retirement account (IRA), tapping into those accounts to finance a home purchase is a tempting option. But stealing your future to pay for your present carries great rewards.
CNBC Select spoke with Chris Kampitsia financial planner from Barnum Financial Group’s SKG team, on how to approach using retirement savings to buy a home and the best strategies to avoid taxes and penalties.
3 Penalty-Free Ways to Use Retirement Savings to Buy a Home
Retirement accounts are tax-advantaged investment accounts designed to help your money grow for use during your golden years. Because the IRS wants you to use these accounts to fund your retirement, early withdrawals usually have consequences; for example, you might have to pay taxes in addition to a 10% penalty.
Given the restrictions on withdrawals from retirement accounts, you may want to change where you save money while planning a home purchase. “If you know you’ll want to make a real estate investment a few years from now, you probably shouldn’t invest all of his savings in your 401(k),” says Kampitsis. For people who expect to buy a home in the next two to four years, Kampitsis recommends low-risk investment options such as a high-yield savings account, money market account, Treasury bonds or I-Bonds.
Right now, some of the best savings accounts have interest rates of 4% or 5%. For example, him Western Alliance Bank Savings Account it currently has an annual percentage yield (APY) of more than 5% and has no monthly fees. And the Marcus by Goldman Sachs High Yield Online Savings the account has no monthly fees other than an APY greater than 4%.
Western Alliance Bank is a member of the FDIC.
Annual Percentage Yield (APY)
Up to 6 transactions each month
Excessive Transaction Fee
The bank may charge fees for insufficient funds
Do you offer checking account?
Offer ATM card?
Although it’s best to use non-retirement accounts to save for a home purchase, there are ways to withdraw retirement funds for a home purchase without paying an additional penalty. But even if you don’t get penalized, you’ll miss out on potential investment gains and risk delaying your retirement plans. You need to be very confident in your retirement savings and your ability to stay on track before you embark on this path to homeownership.
Withdraw Contributions from the Roth IRA
Roth IRA deposits are considered after-tax contributions, which means you can’t deduct them from your taxable income. Since you’ve already paid the taxes, you can withdraw the contributions you’ve made to a Roth IRA at any time without paying additional taxes or penalties. For example, if you have deposited $20,000 into a Roth IRA and your investment has grown to $25,000, you can withdraw the original $20,000 at any time.
However, taxes, and possibly a 10% penalty, may apply when you make an early withdrawal of investment earnings from a Roth IRA. To avoid these taxes and the penalty, you typically must have had the IRA open for at least five years and be at least age 59.5.
Withdraw up to $10,000 of investment earnings from an IRA for a first-time home purchase
If you’re under age 59.5, you still have a way to withdraw earnings from a Roth or traditional IRA without paying a penalty (although you may still be pending taxes).
The IRS allows you to withdraw up to $10,000 penalty-free from an IRA, per person for a lifetime, for a first-time home purchase. You qualify as a first-time homebuyer if you have not owned a primary residence in the last two years. If you’re buying a home with a family member or spouse, you can each withdraw up to $10,000 without penalty from your IRAs, as long as you both qualify as a first-time homebuyer.
Traditional IRAs and Roth IRAs have different rules about the taxes you may have to pay on this withdrawal.
- With a Roth IRA, you may owe taxes on the earnings you withdraw if the account is less than five years old.
- With a traditional IRA, you must pay taxes when you withdraw the money (since, unlike a Roth IRA, you don’t pay taxes on the deposits you make). The first-time homebuyer exception allows you to withdraw up to $10,000 without penalty, but you’ll most likely have to pay tax on the distribution.
Get a 401(k) loan
If you have a 401(k) retirement savings account, you may be able to borrow some of the money you have saved in the account. However, each employer has different rules for 401(k) plans, and a 401(k) loan is not always allowed.
Depending on the rules of your 401(k), you can borrow up to 50% of the account balance (up to a maximum of $50,000). The repayment term of this type of loan usually ranges between 2 and 5 years. And the interest you pay on a 401(k) loan is deposited into your account, so you pay interest on the money.
But there are important caveats to keep in mind with a 401(k) loan, so make sure you understand all the potential risks. If you lose your job or quit, you’ll usually have to repay the loan in full before the next year’s tax deadline; otherwise, you may have to pay taxes and a 10% penalty on the amount you borrowed (if you’re under 59.5). So if you left your job in December, you would have to pay off a 401(k) loan in full by the time you file your taxes in April (unless you request an extension of the tax filing deadline).
Depending on your 401(k) plan, you may be able to make contributions and receive a matching contribution from your employer while you repay the loan. However, some plans will not allow you to contribute to your 401(k) while paying off a loan. That means your company’s 401(k) match would be lost in addition to any potential investment earnings during that time. So make sure you fully understand all the rules for your specific 401(k) before making any decisions.
Low Down and No Down Mortgage Options
Before you dip into your retirement savings, be sure to explore all of your other options first. There are loan programs that require Little or no down payment. VA loans and USDA loans require no down payment, and you can get an FHA loan with as little as 3.5% down.
You’ll also want to see if there are any homebuyer assistance programs in your area. These state and local initiatives provide down payment and closing cost assistance to eligible homebuyers through grants, forgivable loans, and interest-free loans.
Depending on the real estate market, you may be able to negotiate and have the seller cover some or all of your closing costs, instead of asking for a lower price. Keep in mind that the amount a buyer can receive from a seller generally cannot exceed closing costs. The type of mortgage you have may also limit how much the seller can contribute toward closing costs.
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You can use the money you have invested in a retirement account, such as a 401(k) or IRA, to help buy a home. And in certain situations, it’s even possible to withdraw funds from a retirement account without paying the 10% early distribution penalty.
However, there are significant drawbacks and tradeoffs to withdrawing money from your retirement accounts early. Therefore, it’s best to exhaust all your options before tapping into your retirement accounts. Look into homebuyer assistance programs, low down payment mortgages, and consider switching your savings to a non-retirement account, such as a high-yield savings account, as you plan your homebuying strategy.
Editor’s note: The opinions, analyses, reviews, or recommendations expressed in this article are solely those of Select’s editorial staff and have not been reviewed, approved, or otherwise endorsed by any third party.