IRA withdrawal for a home purchase: What you need to know

The average home buyer put down 18% in 2024, reported the National Association of REALTORS^®. It was 9% for first-time home buyers, but it’s still a significant up-front cost when home prices tend to be elevated. You may be tempted to withdraw from your individual retirement arrangement for your down payment. But IRS rules and financial considerations mean you need to be careful withdrawing from and replenishing an IRA.

This article goes heavily into the tax implications of withdrawing from your IRA. It’s not intended to be personalized tax advice. If you have any doubts about reporting accurately to the government, consult a tax professional.

IRA vs. Roth IRA

If you have or are considering an IRA to save for your future retirement expenses, you should be aware that the tax treatment is different depending on whether you have a traditional IRA or a Roth IRA. Traditional IRAs have tax-deferred contributions. You pay the taxes when you make a withdrawal. With a Roth IRA, the taxes are paid when you contribute funds. But you don’t have to pay taxes when you withdraw the money.

People will sometimes opt for a Roth IRA or 401(k) – 401(k)s are employer-sponsored and IRAs are set up by an individual – because they’re placing a bet that taxes will go up in the future. Paying now enables them to guard against that possibility. Of course, it can go the other way if taxes go down.

Contributions to a traditional IRA are deductible from your current taxes. This makes sense because the government doesn’t double dip if you’re going to end up paying taxes in the future. Contributions to Roth IRAs aren’t deductible because you pay the taxes immediately.

Rules to follow when withdrawing IRA funds

Reading tax policy is like when you were younger and your sibling let you have the last scoop of ice cream. You’re getting what you want now, but you know you should be careful because they’ll hold it over you.

In one paragraph, the IRS says you can withdraw money at any time. Of course, two sections down, it’s clarified that if you withdraw money prior to a certain age without meeting an exemption, you’ll pay the price in the form of penalties.

Early withdrawal penalty when using IRA funds

If you make an early withdrawal – also called a distribution – of your IRA funds, you may have to pay a 10% additional tax on the early withdrawal. Regardless of your age, if you take a distribution from a Roth IRA as a first-time home buyer within 5 years of the start of the year you opened it, there’s a 10% tax penalty on the earnings, without exception. If you take a distribution of $10,000, the penalty would be $1,000 if it’s a traditional IRA.

If it’s a Roth IRA, it works a little differently. Contributions are never taxable because you’ve already paid the taxes. In the event of an early distribution, investment earnings and certain conversions are what may matter. You can find the taxable amount by filling out Form 5329.

If you have a traditional IRA or have met the 5-year rule for Roth IRAs, there are a number of exemptions to the 10% tax penalty. We’ll discuss the first-time home buyer exemption and a couple of the other common ones.

First-time home buyers

You can withdraw up to $10,000 over the course of your lifetime to buy, build, or rebuild your first home. To be considered a first-time home buyer, the IRS dictates that you can’t have had ownership in a primary residence during the 2-year period prior to acquiring the home. If you’re married, the requirement also applies to your spouse. Your spouse can also make the same $10,000 penalty-free withdrawal.

The date of acquisition is considered the day you enter into a contract to buy an existing home. If the home is being built or rebuilt, it’s the day construction starts.

You’re not limited to spending the money on your own house. You can use your IRA withdrawal to contribute to the purchase of a home for any of the following people, as long as they’re first-time home buyers:

• Yourself
• Your spouse
• Your or your spouse’s child
• Your or your spouse’s grandchild
• Your or your spouse’s parent or other ancestor

For this to be considered a first-time home buyer distribution, you have to use the funds toward home purchase costs before the end of the 120^th day after you receive them. The IRS considers the following home purchase costs:

• Costs to buy, build, or rebuild the home
• Any usual or reasonable settlement, financing, or other closing costs

Unfortunately, sometimes home purchase or construction falls through. In that case, you can avoid an early distribution penalty by contributing the amount withdrawn within 120 days of the original distribution.

Death of the IRA owner

If an IRA owner passes prior to taking any distributions, beneficiaries generally base their required minimum distributions on their life expectancy. In some cases, the IRA has to be fully distributed within 10 years if the beneficiary elected this or if the beneficiary wasn’t an eligible designated beneficiary. A separate 5-year full distribution rule applies if the beneficiary of the IRA is an estate or trust.

If the IRA owner dies on or after the date when they begin taking distributions, designated beneficiaries base minimum distributions on either single life expectancy or the owner’s life expectancy, whichever is greater. Without a designated beneficiary, the owner’s life expectancy is used. Exceptions include surviving spouses and ineligible designated beneficiaries:

• Surviving spouses may calculate life expectancy differently.
• Ineligible designated beneficiaries have to take all distributions within 10 years of the owner’s death.

59½ years old or older

At 59½, you’re considered retirement eligible by the IRS and can withdraw from your IRA penalty free. While the age is a bit arbitrary, this is when the government figures you could very well be retired and pulling from retirement funds. You would pay taxes on any distributions from a traditional IRA, but there’s no additional penalty. Roth distributions are tax-free.

How to withdraw from an IRA for a home purchase

If you’re looking to withdraw from an IRA to purchase a home, you can take the following steps:

• Contact the administrator of your IRA. The administrator will be able to give you details regarding next steps.
• Fill out any necessary forms. There’s likely to be paperwork to fill out letting your administrator know, among other details, how much you want to withdraw.
• Get the funds. Make sure there is a record of the transaction because the funds may need to be sourced for the mortgage lender.
• Use the funds within 120 days. This time frame is the last hurdle to avoid paying a tax penalty. If the deal falls through, simply contribute the money again by the end of this period.

Pros and cons of making an IRA withdrawal for a home purchase

We’ll go over alternatives in a few paragraphs, but withdrawing from your IRA isn’t the only option. Make sure you’re aware of the upsides and downsides.

Pros

• You’re able to buy a home. If you’re having trouble coming up with the necessary funds for a down payment, an IRA withdrawal could be the thing that helps make homeownership a reality.
• You can qualify for penalty-fee exemptions. As long as you meet first-time home buyer qualifications, there’s no tax penalty associated. You can withdraw $10,000 ($20,000 with a spouse).
• It's not a loan. Because there’s no borrowing involved, there’s nothing to pay back.

Cons

• Less money in retirement. Even if you plan to contribute more to your IRA later to make up for taking the funds out, that’s time that you’re not earning returns on the money if it were in your account. You could get data for the returns on your IRA going back as far as you can and match the withdrawal plus earnings later. But even if you have the resources, there’s no guarantee the funds wouldn’t have outperformed historical returns had they been left there. You could be leaving money on the table.
• Penalty fees. If you withdraw more than $10,000 ($20,000 if married) prior to age 59½, you’ll have to pay a 10% early withdrawal penalty in addition to any other income tax that may be owed based on the distribution.
• It’s not a loan. Yes, this is both a pro and a con. Other retirement tapping options involve a loan that you pay back with interest so that you don’t lose out on money you could have been earning when it’s withdrawn.

Alternatives to withdrawing from your IRA

Withdrawing from your IRA has negative implications for your retirement savings because any money you withdraw now takes away from money you could be using later in life. That’s before considering the potential tax implications associated with an early withdrawal. There’s also the practical reality that $10,000 may not be enough to fund your down payment. Here are alternatives to consider:

• Take a retirement loan. This isn’t always available, but employers can offer retirement account loans. The loan can be $50,000 or 50% of your account balance, whichever is less. If 50% of your balance is less than $10,000, you can borrow up to $10,000. Ask your employer about loan terms. If enough interest is charged, you may not be giving up money for retirement. You’re paying back your future self.
• Look into down payment assistance. Down payment assistance can be used for that purpose and for other closing costs. It typically comes in the form of grants, forgivable loans, deferred loans, or loans that are immediately repayable. Confirm what your lender will take before accepting assistance.
• Consider gift funds. Family members can gift you funds for a down payment. In some circumstances, it can even come from your union, employer, or a government agency that provides homeownership assistance to low- or moderate-income or first-time home buyers. If you’re getting a discount buying through a family member, this can go toward your down payment as a gift of equity.

FAQs about IRA withdrawals for a home purchase

Now that we’ve touched on the ins and outs as well as the pros and cons, let’s answer a few questions.

Can I withdraw from my IRA as a first-time home buyer?

You can withdraw from an IRA at any time. However, being a first-time home buyer means that you won’t be subject to a tax penalty as long as you haven’t had ownership interest in a main home in the 2 years prior to your purchase. You and your spouse, if you have one, can withdraw up to $10,000 without an additional tax penalty. Standard income tax may still apply.

Can I use my Roth IRA to buy a house?

Yes, like a traditional IRA, a Roth IRA can be used to buy a house. However, the same 10% additional tax penalty applies if you don’t meet the requirements for first-time home buyer status or another exemption. In the case of a Roth IRA, the 10% tax may apply on earnings. Income tax doesn’t apply when withdrawing past contributions because these are contributed after taxes are removed

Is it a good idea to withdraw from my IRA for a house?

We’ve talked at length about the tax implications of withdrawing from your IRA. But the other thing to keep in mind is the potential lost earning potential in your retirement fund that you would see if you left the funds in your account. You can try to calculate lost earnings, but you could still end up losing money if the fund outperforms your expectations.

How do I report an IRA withdrawal on my taxes?

Regardless of whether the IRA withdrawal is a qualified one, you’ll need to report any taxable income from the distribution on your 1040. If you have to pay a 10% tax penalty for a nonqualified distribution, you may need to fill out IRS Form 5329. Be sure to consult a tax advisor.

The bottom line: An IRA withdrawal for a home purchase is possible

Although you can do an IRA withdrawal at any time, many of these involve a penalty if completed before age 59½. However, there is an exemption for withdrawals up to $10,000 for a home purchase as long as you’re a first-time home buyer. It’s important to note that depending on the type of IRA you have, the distribution may still count as taxable income.

In addition to the potential for penalties, when determining if this is the right strategy for you, take into account its effect on your future retirement savings. Consult a financial advisor before undertaking any particular investment strategy. 

If you’re ready to move forward purchasing a home, you can start your mortgage application today. Our Home Loan Experts are also standing by at (833) 326-6018.