Author Topic: Unsure if buying a home. Save cash or use Roth contributions when time comes?  (Read 551 times)

DeepGlue

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Hey all! Super useful forum, thanks for all the insight posted up here. I've been searching around here and elsewhere trying to figure out the answer to this, and have found a half dozen threads talking about using Roth funds for a down payment. My impression from those is that it depends on the situation but is usually a bad idea. But I must be missing something, so thought I'd post.

Theoretical but representative scenario: My spouse and I are not sure if we want to buy a house or not. But if we did, we would need $51k for a down payment + closing costs + fix-up costs. We currently save $51k a year and put it all into maxing out the IRA and 401(k) accounts. We are starting from $0 saved aside from retirement, emergency fund, and checking slush. We have $51k in existing Roth IRA contributions, which we could withdraw at any time with no taxes or penalties.

What's the difference between 1) diverting $51k of savings from retirement accounts and putting it in a savings account instead, and 2) withdrawing our $51k in existing Roth IRA contributions? Seems to me that either way, we're taking from our retirement to make the payment. Which I guess makes this a question of if and when we need the payment, and how the market is doing:
  • If we know we want to buy in a year, and 1) divert money to savings:
    • If the market does well over the next year, we take a big hit in opportunity cost.
    • If the market does poorly over the next year, good for us.
  • If we're ambivalent about buying, and 2) keep putting all savings into retirement, but we suddenly change our mind:
    • If the market did well in the past year, pull out the Roth contributions, good for us.
    • If the market did poorly in the past year, we either can't buy, or take a big hit.
In any given year, the market is more likely to do well than poorly. So if we're ambivalent about buying, I can't see option 1) as being viable. But even if we're "pretty sure" we want to buy... if we're not certain, it still seems like 2) is the better option. And even if we were certain... if we're okay with the risk, 2) still seems pretty viable. What am I missing here? Thanks!

Sibley

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There may be tax consequences to pulling money out of the Roth. If you're going to pay a penalty, then don't pull it from the Roth.

DeepGlue

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Thanks. I'm talking about withdrawing *only* the Roth *contributions* which I do believe can be done at any time with no tax or penalty. Not the earnings, which I think are subject to a couple layers of 5-year rules.
« Last Edit: May 04, 2021, 01:29:30 PM by DeepGlue »

DeepGlue

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Actually, wow. If we decide we're going to buy in a year and are worried about market risk in that time, we could just convert $51k of index funds within the Roth IRA to cash in the Roth IRA (again these are only the contributions, not earnings, so I believe can be withdrawn without tax or penalty). Then we can continue contributing to the retirement accounts (reducing taxable income), AND have the cash in a year. This seems like the best approach to me.

uniwelder

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Actually, wow. If we decide we're going to buy in a year and are worried about market risk in that time, we could just convert $51k of index funds within the Roth IRA to cash in the Roth IRA (again these are only the contributions, not earnings, so I believe can be withdrawn without tax or penalty). Then we can continue contributing to the retirement accounts (reducing taxable income), AND have the cash in a year. This seems like the best approach to me.

Are you going to start selling some of your funds off now to build that cash reserve in the roth ira?  Or wait until you're more certain whether you plan to buy?

I also saw that for first time home purchases, it seems like you can withdraw 10k of earnings penalty free from the roth, so assuming you're talking about 2 accounts, that's 20k.

This is a bit of an aside--- I find your numbers very curious.  You 1) will need 51k for the down payment, 2) happen to save 51k/year total, and 3) currently have 51k in your roth accounts?  I assume this is all hypothetical because while #2+3 might be true, how do you know #1?  Why choose 51k as your number?  50k is rounder and easier on the brain.

DeepGlue

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I chose $51k for my example because that's exactly what a couple can contribute to 401(k) and IRA in one year ($19.5k x 2 + $6k x 2). Felt like a simpler thought experiment: either 1) put nothing into retirement for exactly a year to save the DP ("safe" but likely to have an opportunity cost), or 2) withdraw Roth contributions right when we need a DP (risky, but if we're all right scrapping our buying plans the statistically better option).

But now I realized (I think) we can sell off Roth contributions for cash *within* the Roth. We'd wait until we decided we *want* to buy. Assuming once we know we expect to, it won't be for ~8 - 18 months. If at that moment the market has just corrected... go with plan 1) instead. Seems like the plan with the most options. I think.

Good point on the $10k x 2 first-time-buyer option. I'd noticed that but hadn't thought about doing it. But all this is really about the difference between taking money OUT of retirement, vs. NOT putting money IN retirement, and the timing of decisions. If that's an option too, it should be included in my reasoning.


DeepGlue

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...we can sell off Roth contributions for cash *within* the Roth. We'd wait until we decided we *want* to buy. Assuming once we know we expect to, it won't be for ~8 - 18 months. If at that moment the market has just corrected... go with plan 1) instead. Seems like the plan with the most options. I think.

However, if the market has just corrected... it might be even better to be sure we're pumping into it? Or is that timing the market? Or is there some timing the market wrapped in all of these ideas? This stuff is so hard to think about.

Finances_With_Purpose

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Save cash.  You can't put those Roth contributions back in, and those are immensely helpful for later tax planning, especially if you do FI.  Just save the cash up. 

DeepGlue

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My point is that I'm just not seeing a difference between 1) saving cash which means NOT contributing to tax-advantaged accounts for a year, and 2) taking out a year's worth of tax-advantaged contributions, which we can do because we have so much Roth contribution due to past decisions. Perhaps a unique situation folks here don't encounter much? The only differences I see are related to timing and risk - I don't see any difference in time to FI, and it might be most advantageous to convert to cash within the Roth once we know we expect to buy in a year, since we can then keep contributing and deferring taxes.

Finances_With_Purpose

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You'll be taxed on all future returns on the cash you haven't yet saved that isn't in Roths.  Plus you lose your returns for X years while you re-save that cash.  And third, realistically, most people spend way more rather than save more once they buy, so you're not as likely to restock that cash as you think; homes are expensive. 

DeepGlue

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Thanks - I do appreciate all the feedback. More than happy to save going forward if that's the right decision. Just still not convinced that it is.

You'll be taxed on all future returns on the cash you haven't yet saved that isn't in Roths. 

Could you explain a bit more? Can't figure out your meaning. We wouldn't be reinvesting this cash in a taxable account. It'd go to the house.

Plus you lose your returns for X years while you re-save that cash. 

By re-save you mean re-add $51k to our 401(k) and IRA? In the example, it will take a year to re-save the $51k, built up paycheck by paycheck. Just like it will take a year of NOT contributing to save the cash up. The only difference I see is that in the former scenario, we keep making tax-deferred contributions to retirement accounts but in the latter scenario we don't - we pay tax on all of our income for that year we're saving.

And third, realistically, most people spend way more rather than save more once they buy, so you're not as likely to restock that cash as you think; homes are expensive.

This is worth considering, and in the example the $51k theoretically covers the DP, closing costs, and immediate upkeep/repair needs.