How Much of Retirement Savings Can You Use to Buy Your First House?

Your retirement funds may help you make a down payment on a first home.

Your retirement funds may help you make a down payment on a first home.

Scraping together extra money each month to buy a home can be difficult, so you might be looking at your retirement account balances as a way to make your down payment. If you're going to raid your retirement plan for a first house, you're usually better off taking the money from an individual retirement arrangement, commonly known as an IRA, than from an employer-provided plan such as a 401(k). However, a loan from an employer plan might be a beneficial option.

Unlimited IRA Withdrawals

You're allowed to take out any amount of money from your IRA whenever you want, but you might owe extra taxes and penalties if you're under 59 1/2 years old. With traditional IRAs, unless you've made nondeductible contributions, you'll usually pay taxes and a 10 percent penalty on distributions. If you're taking money from a Roth IRA, you can remove all of your contributions, which come out tax-free and penalty-free, first. Only after exhausting them all will you tap the earnings, which are taxed and penalized when you take an early distribution.

First-Time Homebuyer Exception

There is one big exception to the penalty rule on traditional IRA withdrawals -- if you are under 59 1/2 and you qualify as a first-time home buyer, you can avoid paying the 10 percent early withdrawal penalty on up to $10,000 of your distribution, although you will still have to pay current income taxes on any money you take out. To be a first-time home buyer, you, and your spouse if married, can't have owned a home within the prior two years. In addition, the distribution has to be used for either purchasing the home or paying for the finance charges associated with buying the home within 120 days of taking the distribution.

Tax Effects of Exception

If you take your distribution from a Roth IRA, your contributions can come out tax free and penalty free at any time -- you have already paid taxes on them, so the IRS will let you take them whenever you want them. You can also withdraw up to $10,000 in earnings without paying taxes or the 10 percent penalty if you use the money on your first-time house, even if you are not yet 59 1/2, with one caution -- you must have had money invested in a Roth IRA account for at least five years before you take the withdrawal. Otherwise, taxes and the penalty will apply to any withdrawal of earnings. The first-time home buyer definitions for a Roth IRA, by the way, are the same as those for a traditional IRA.

Employer Plans

You might be able to tap your employer retirement plans, such as a 401(k) or 403(b), either in the form of a loan or a hardship distribution for your first home. With a loan, you're generally limited to the smaller of 50 percent of your vested account balance or $50,000. However, you can extend the repayment period for more than five years since your using the loan for purchasing your primary residence, if your plan allows. With a hardship distribution, you can take out the amount you need to satisfy the financial need. However, employer plans don't exempt these distributions from the 10 percent additional tax on early withdrawals. And you'll pay current income taxes on the withdrawals. For example, if you take a $10,000 hardship distribution from your 401(k) to pay for the down payment, not only is it taxable, but you'll also owe $1,000 in penalties.

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