Using Retirement Funds to Buy a House | Can I and How?

December 27, 2022 by Karen Thomas-Brandt, EA
IRA and 401k written on eggs with a money background

Buying a new home is a fun, exciting time in your life! It is also one of the biggest decisions you will ever make because there are many things to consider. Where do you want to live? How are the schools in that area? Are there parks and walking trails nearby? How big of a house do you need or want? And one of the biggest considerations: Can you afford to buy a house? In answering this last question, you may wonder if using retirement funds to help with a home purchase is a good option or even a possibility.

When considering retirement funds as an option to help pay for a new home (or, perhaps, the down payment on a new home), there are generally two common options taxpayers can consider: A 401(k) plan or an IRA. Generally, with either plan, if you are under age 59 ½ and take money out of the fund, you will incur a 10% early withdrawal penalty (plus whatever penalty your state may assess) unless you qualify for an exception. In addition to that, you may pay income tax on whatever amount you withdraw. Let’s look at each of these options individually.
 

Option 1: 401(k) funds

When taking funds from a 401(k), you generally have two possibilities:

 

  1. You can borrow from your account. A loan from a 401(k) would generally need to be paid back over five years. However, this time period will be shorter if you leave your job or are laid off. The limit on the amount you can borrow is the lesser of:
    • $10,000, or half of your vested balance (whichever is more), OR
    • $50,000.
  2. You can take a “hardship withdrawal.” Whether or not a home purchase is considered a hardship withdrawal is determined by your employer, but you would still be subject to a 10% penalty if you are under 59 ½.


While a loan may seem like the perfect option in this case (after all, there are no income tax implications, and no penalty is imposed), there are a few things to keep in mind when considering a 401(k) loan. While you are in the “payback period” of the loan, all funds you put into your 401(k) account are considered loan repayments and not contributions (i.e., no employer match and no tax break), and you lose the growth opportunity you would have received had you not taken the loan. Also, it is possible that a 401(k) could work against you in obtaining financing for the rest of the mortgage, as it could count against your debt-to-income ratio.
 

Option 2: IRA funds

Usually, you will have one of two types of IRAs:

 

  1. Traditional IRA – As mentioned above, if you take money out of your traditional IRA and are under 59 ½, you will incur a 10% early withdrawal penalty. However, if you are a “first-time homebuyer” (generally defined as you - or your spouse, if applicable - not having owned a home in the last two years), you may qualify for an exception to the 10% penalty on up to $10,000. If you are married, you and your spouse can each take a $10,000 distribution penalty-free. Remember, though, that the funds in your traditional IRA may be pre-tax, and when you take a distribution, you will have to pay income tax on that distribution.
  2. Roth IRA – If you have owned a Roth IRA account for at least five years and are over 59 ½, you will have no income tax implications nor a penalty on a distribution (this is great news!). However, if you have not owned a Roth for at least five years or are not over 59 ½, you may be subject to that 10% penalty on any distribution of earnings (remember, a Roth IRA is post-tax money, so income tax has already been paid on your contributions). The good news is that, like a traditional IRA, you (and your spouse) can withdraw up to $10,000 (as a qualified first-time homebuyer) with no penalty.
 

I heard I can buy property in my IRA – Can I buy my house that way?

After all this, you may decide that you prefer not to take a distribution from your IRA accounts or borrow from your 401(k). After all, reducing the account balance reduces any growth you earn in that account, and the tax hit for including the income from a traditional IRA can be considerable. You also may not have the income to pay a mortgage and a 401(k) loan. Since the amount you can withdraw from a traditional IRA would be subject to a penalty if you are not yet 59 ½ years old, and the penalty exemption amount for first-time home buyers is low, you very likely would need to take more from the account than you can exempt from the penalty. Housing prices have skyrocketed throughout the pandemic and are only now showing signs of cooling down again. So, you may wonder if there’s another way.

If you’ve been searching the internet for information about using your retirement funds to buy property, you may have come across some websites that discuss purchasing real property in your IRA account. While it is true that your IRA can hold any kind of investment, including real property, in addition to the normal stocks and bonds, what many of these sites fail to explain are the limits and risks of buying real property using an IRA and keeping that property as an IRA asset. Purchasing property in an IRA is very complicated, and you cannot purchase property in an IRA for your personal use, such as a personal residence. Doing so would immediately disqualify your IRA as a nontaxable IRA account, and the entire balance would be deemed distributed to you. Depending on your account balance, that could be very painful tax-wise. You can learn more about buying property within an IRA in our blog on this topic.

Buying a home is a big decision. Figuring out how to pay for it can be an even bigger decision, and you will want to avoid incurring a large tax bill for doing things incorrectly. As with all big decisions, you may want to consult a tax professional for advice before you make your financial moves. But if you have done this and are now looking at an IRS notice because something went wrong or you did not report it correctly, you can always count on TaxAudit to help you out. Our prepaid audit defense is your best bargain when buying a home, as there are many areas on your tax return that can be affected by a home purchase. Audit protection can provide the peace of mind you need should an audit arise. If you need help or have questions, please visit https://www.taxaudit.com/prepaid-audit-defense.

SEARCH

 

Karen Thomas-Brandt, EA
Resource Manager

 

Karen Thomas-Brandt, EA, is a Resource Manager at TaxAudit, the largest and fastest-growing audit defense service in the country and the exclusive provider of TurboTax® Audit Defense. With more than 17 years in the tax field, Karen has prepared thousands of tax returns and defended hundreds of taxpayers in audits. In her current role, Karen specializes in coaching and mentoring tax professionals so that they have the skills to best represent our members and love where they work!


 

Recent Articles

Tax Returns, plant, and $100 bills laying on a desk
What happens if your spouse overstated the deductions claimed on the return or substantially understated the income?  Are you still liable for the tax due?
wedding cake split with man on one side and woman on the other
Alimony payments may indeed be tax deductible if the divorce or separation instrument under which they are made was executed prior to 2019.
Double Taxation written on notepad
Most states that have income taxes offer a credit for taxes paid to another state on the same income, although how that credit is calculated is not identical.
File Cabinet with Documents
IRS notice CP05A is sent by the IRS to inform taxpayers that they need more information about the submitted income tax return before a tax refund can be issued.
This blog does not provide legal, financial, accounting, or tax advice. The content on this blog is “as is” and carries no warranties. TaxAudit does not warrant or guarantee the accuracy, reliability, and completeness of the content of this blog. Content may become out of date as tax laws change. TaxAudit may, but has no obligation to monitor or respond to comments.