IRS regulations offer a break to first-time home buyers who withdraw funds from a Roth IRA. Typically, income earned in a Roth IRA can only be withdrawn tax free after the account holder has passed the age of 59 1/2.
Non-qualified distributions before that age are charged a 10% withdrawal penalty to discourage investors from withdrawing money outside of retirement.
However, the IRS makes an exception for up to $10,000 withdrawn for qualifying first-time home buying expenses.
Who Qualifies as a First-time Home Buyer?
The penalty free withdrawal is available to individuals who are buying, building, or rebuilding a first home. The new home buyer cannot have had any interest in the home being purchased or rebuilt for the two years prior to the date the purchase.
If the home buyer is married, then his or her spouse cannot have had any interest in the property for those two years either.
Married couples who purchase a qualifying home together can withdraw $10,000 from each spouse’s Roth IRA for down payment, up to a total of $20,000.
The home buyer does not have to be the individual who owns the Roth IRA.
Qualified Roth IRA withdrawals may be used on behalf of the account holder, his or her spouse, their child, grandchild, parent, or other ancestor.
How Can I Spend the Roth IRA Money?
Acceptable expenses are defined by the IRS as “qualified acquisition costs.” This definition includes using the funds from a Roth IRA for down payment on a new home, paying settlement fees, obtaining financing, and paying closing costs.
Because the IRS guidelines include building and rebuilding a first home, Roth IRA withdrawals can also be used for construction expenses in those circumstances.
All funds withdrawn as a qualified distribution must be spent within 120 days of receipt, so plan your expenses accordingly and do not withdraw more money than you will need.
How are Qualified Home Buying Distributions Taxed?
Unlike a traditional IRA in which qualified distributions are taxable as ordinary income, a qualified distribution from a Roth IRA is not taxable.
The only limitation to taking out tax free funds is that no qualified distributions may be taken from a Roth IRA until the account has been open and funded for at least five years.
Note that only the income earned in Roth IRA is subject to the rules of qualified distributions. Principal contributions to a Roth IRA may be withdrawn at any time without incurring penalties or taxes.
What Happens After I Take My Qualified Roth IRA Withdrawal?
First-time home buyer withdrawals do not have to be repaid to the Roth IRA, as opposed to using a 401(k) loan for your down payment.
You will not be eligible to contribute “make-up” payments beyond the standard $5000 and $6000 annual contribution limits.
The amount withdrawn from your Roth IRA will reported to the IRS by the custodian of your account, and you will receive a 1099-R. If you are preparing your own taxes, you can use the information from the 1099-R to report your qualified distribution on IRS Forms 5329 and 8606.
Qualified Roth IRA withdrawals are attractive option for those in the market for their first home. If you meet the IRS requirements, you will be able to benefit from your investments tax free.
Before withdrawing your funds, think carefully about how you will replenish your retirement savings, and make sure that your new house is a sound investment.