Penalty-free IRA withdraw?!

[JordanOfGilead]

I just discovered that first time home buyers in the US can draw up to $10,000 from their IRA without the standard 10% penalty if they use the money as a down-payment on a house within 120 days. If it is a traditional IRA, the buyer would have to pay income taxes, but since mine is a Roth, there are no taxes or penalties associated with the withdraw.

I don't have 10k in my Roth IRA yet, but I do have a sizeable chunk in an old employer traditional 401k that I can roll into my IRA after paying taxes on it, at which point I wil lbe able to use the full 10k limit toward a down payment on the DW and I's first home.

Having focused on paying off debt and not so much on saving lately, this information came as a wonderful surprise to us and I thought I would share.

[StockBeard]

If it is a traditional IRA, the buyer would have to pay income taxes, but since mine is a Roth, there are no taxes or penalties associated with the withdraw.

It is so confusing to me that these kind of differences exist between the two types of accounts... why...? How about withdrawing from the 401k directly, does the same 10K benefit apply?

[MDM]

How about withdrawing from the 401k directly, does the same 10K benefit apply?

It depends on the language in your specific plan.  The IRS says a plan "may" - but that also means it "may not."

See https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/401k-Resource-Guide-Plan-Participants-General-Distribution-Rules and https://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Hardship-Distributions.

[dude]

I just discovered that first time home buyers in the US can draw up to $10,000 from their IRA without the standard 10% penalty if they use the money as a down-payment on a house within 120 days. If it is a traditional IRA, the buyer would have to pay income taxes, but since mine is a Roth, there are no taxes or penalties associated with the withdraw.

I don't have 10k in my Roth IRA yet, but I do have a sizeable chunk in an old employer traditional 401k that I can roll into my IRA after paying taxes on it, at which point I wil lbe able to use the full 10k limit toward a down payment on the DW and I's first home.

Having focused on paying off debt and not so much on saving lately, this information came as a wonderful surprise to us and I thought I would share.

We used this exception to boost our house down payment when my wife changed jobs and rolled her 401k over into an IRA.

[robartsd]

I'd be inclined to roll the 401k into a traditional IRA regardless of any other decisions of what to do with these accounts. At that point you can choose to use either IRA for house downpayment (if you're really determined to raid your retirement accounts as much as possible you can take 10k from the traditional and all contributions to the ROTH). I'd prefer to leave enough contribution headroom in the ROTH that it can also serve as an emergency fund.

I also question if this is the right section of the forum to be discussing this approach as raiding retirement accounts for a house downpayment does not sound like badassity to me.

[JordanOfGilead]

If it is a traditional IRA, the buyer would have to pay income taxes, but since mine is a Roth, there are no taxes or penalties associated with the withdraw.

It is so confusing to me that these kind of differences exist between the two types of accounts... why...? How about withdrawing from the 401k directly, does the same 10K benefit apply?

The difference between an IRA and a 401k is essentially the type of investment and limit to annual contributions. The difference between roth and traditional is whether the money is contributed pre or post tax. I have a 401k in an account from a previous employer and could either roll it into my current employer's 401k plan (my original plan) or into my personal Roth IRA. If I kept it in a 401k format, I would have to pay income taxes on the amount I withdraw plus an early withdraw penalty to use the money toward a down payment. If I roll it into my IRA, I only have to pay the income taxes but not the early withdraw fee due to an "incentive" in federal regulations for first-time home buyers.

I'd be inclined to roll the 401k into a traditional IRA regardless of any other decisions of what to do with these accounts. At that point you can choose to use either IRA for house downpayment (if you're really determined to raid your retirement accounts as much as possible you can take 10k from the traditional and all contributions to the ROTH). I'd prefer to leave enough contribution headroom in the ROTH that it can also serve as an emergency fund.

I also question if this is the right section of the forum to be discussing this approach as raiding retirement accounts for a house downpayment does not sound like badassity to me.

The description of the forum says "Describe a tip, trick or technique that you have discovered, and would like to share with your friends."
While I agree, it's not the greatest thing to raid retirement funds for a large purchase, this enables me to pay down higher interest (student loan) debt without interruption while building equity as opposed to reducing my student loan payments to the minimum required while I build equity and I think that's pretty bad ass.
Forgoing the 10% early withdraw penalty is also a "trick or technique" that I discovered and felt needed shared with the younger readers that have yet to buy a home.

If there is a more appropriate location for this thread, I have no objection to it being moved. That was just my train of thought when posting.

[Jack]

Just because you can do that doesn't mean you should do it. Once you withdraw from the IRA, you can't put the money back: even if you saved up the money to "repay" it, you have to leave it in a taxable account and thus miss out on decades of tax-free growth.

IMO, raiding your IRA like that is worse than taking a 401k loan (give or take the risk of losing your job before paying the latter back).

[JordanOfGilead]

Just because you can do that doesn't mean you should do it. Once you withdraw from the IRA, you can't put the money back: even if you saved up the money to "repay" it, you have to leave it in a taxable account and thus miss out on decades of tax-free growth.

IMO, raiding your IRA like that is worse than taking a 401k loan (give or take the risk of losing your job before paying the latter back).

It's either raid my IRA or make a smaller down payment. The 4.5% interest rate on the mortgage I qualify for in addition to the extra interest that would accrue on my student loans while I slowed my payments would come out to a greater loss over ten years than my IRA is projected to gain.. It's also sort of a time sensitive purchase so I don't have very long to pull together a down payment.
Additionally, this gets me out of renting in an area where it is much more expensive to rent than to own.

It's not ideal, but the option to use money that is mine without having to pay the government for the right to use it when I need it is helpful and not necessarily something that is well known.

[Jack]

Just because you can do that doesn't mean you should do it. Once you withdraw from the IRA, you can't put the money back: even if you saved up the money to "repay" it, you have to leave it in a taxable account and thus miss out on decades of tax-free growth.

IMO, raiding your IRA like that is worse than taking a 401k loan (give or take the risk of losing your job before paying the latter back).

It's either raid my IRA or make a smaller down payment. The 4.5% interest rate on the mortgage I qualify for in addition to the extra interest that would accrue on my student loans while I slowed my payments would come out to a greater loss over ten years than my IRA is projected to gain.. It's also sort of a time sensitive purchase so I don't have very long to pull together a down payment.
Additionally, this gets me out of renting in an area where it is much more expensive to rent than to own.

It's not ideal, but the option to use money that is mine without having to pay the government for the right to use it when I need it is helpful and not necessarily something that is well known.

I'm not saying it's always a bad idea; just that it's not necessarily a good one. I'm just saying that one should always do the math and account for the opportunity cost.

I bought my house with a very small down payment and an FHA loan, by the way. Even with PMI, it was totally worth it vs. delaying the purchase until I'd saved up more money, so I understand your perspective. However, before pulling the trigger I suggest you consider the possibility of getting an FHA mortgage, using the money you save on rent to pay down to 80% LTV (while still maxing your IRA), and then refinancing to a conventional mortgage ASAP.

[JordanOfGilead]

Just because you can do that doesn't mean you should do it. Once you withdraw from the IRA, you can't put the money back: even if you saved up the money to "repay" it, you have to leave it in a taxable account and thus miss out on decades of tax-free growth.

IMO, raiding your IRA like that is worse than taking a 401k loan (give or take the risk of losing your job before paying the latter back).

It's either raid my IRA or make a smaller down payment. The 4.5% interest rate on the mortgage I qualify for in addition to the extra interest that would accrue on my student loans while I slowed my payments would come out to a greater loss over ten years than my IRA is projected to gain.. It's also sort of a time sensitive purchase so I don't have very long to pull together a down payment.
Additionally, this gets me out of renting in an area where it is much more expensive to rent than to own.

It's not ideal, but the option to use money that is mine without having to pay the government for the right to use it when I need it is helpful and not necessarily something that is well known.

I'm not saying it's always a bad idea; just that it's not necessarily a good one. I'm just saying that one should always do the math and account for the opportunity cost.

I bought my house with a very small down payment and an FHA loan, by the way. Even with PMI, it was totally worth it vs. delaying the purchase until I'd saved up more money, so I understand your perspective. However, before pulling the trigger I suggest you consider the possibility of getting an FHA mortgage, using the money you save on rent to pay down to 80% LTV (while still maxing your IRA), and then refinancing to a conventional mortgage ASAP.

That's pretty much the plan. I spent most of the day yesterday talking to my realtor and the mortgage representative. Neither of them care much which way I go as long as I make the purchase. Beyond that, it doesn't affect what they get out of the deal, so I was able to get some decent information about my different options.
Although it really bothered me that it took almost an hour to get through to the mortgage guy and let him know that I wasn't looking to minimize my monthly payment, I was looking to minimize my long-term cost...

[eyePod]

We decided on not touching our investment accounts, only putting 10% down, and aggressively paying to get out of PMI. We ended up paying $1227.60 and fighting like hell to get out of PMI early.

They argued that the loan wasn't "seasoned" which is only something that their investors care about and wasn't stated within our PMI agreement. We mentioned legal action and they backed down (I had a discussion about it on here where we noted that they technically didn't have to do anything even though we qualified for PMI removal).

We also just got a check for $49.10 in "extra" PMI payments since it got cancelled within the middle of a month.

We figured the $1227 in PMI payments was worth getting the house we wanted in the neighborhood we wanted and the price we could afford.