We recently talked to a young investor about purchasing her first home. After covering the basics on obtaining pre-approval, applying for a mortgage, and what may be tax deductible, she then asked about borrowing money from her retirement accounts to cover the down payment. Then she threw us a curveball. She also wanted to be able to get the money she borrowed back into her retirement accounts once her windfall came in.
While her exact situation was unique to her, we often see people who plan a major purchase around the time they’re expecting an influx of cash, whether it be from selling a separate piece of property, an inheritance, or a bonus at work.
The IRS currently allows you to do one “indirect rollover” per 12-month period. So, you could effectively “borrow” from one account or the other, for up to 60-days, only if you put the money back in the account before that 60-days expires. It would be considered tax- and penalty- free. However, this carries a great deal of risk because failure to put the funds back within 60 days will result in a distribution, subject to applicable taxes and/or penalties.
Furthermore, all retirement accounts (both IRA and Roth) are consolidated for tracking purposes. You can’t borrow $50,000 from both your Traditional IRA and your Roth IRA. One would count as a rollover, while the other would be considered a distribution.
The IRS allows you to pull funds from a Traditional IRA account without penalty for a first-time home buyer up to $10,000. You are considered a first-time home buyer if you, or your spouse, haven’t owned a principal residence at any time during the past two years. While this money is still taxable, you do avoid the 10% penalty that is applicable to withdrawals from IRAs prior to age 59½. Any additional funds above $10,000 will be subject to taxes and 10% penalty if you are younger than 59½. You will not be able to get the funds back into the IRA after they have been withdrawn, as you are limited to a maximum contribution of $5,500 a year, so you are giving up the tax-deferred growth benefit of those funds.
Unlike a traditional IRA, you can always take your contributions out of a Roth IRA, tax and penalty free because it’s your money that has already been taxed. The IRS allows distributions of growth on the Roth money up to $10,000 without penalty for first-time home buyers, and possibly without tax, if you meet the five-year holding period requirements. Distributions from the Roth are going to be the most flexible, but the rules for taxes and penalties depend on whether the money is from contributions, conversions, or earnings. The biggest downside to withdrawing from the Roth is losing the tax-free growth of those assets, since you cannot get the money back in after it has been distributed.
However, if you have a unique and specific need for a short-term loan, your 401(k) plan may be an option. The IRS allows participants of qualified plans, such as a 401(k), 403(b) plans and some governmental 457(b) plans, to take loans from their plan balance. In general, you can borrow the greater of $10,000 or 50% of your vested account balance, up to $50,000. Specific loan terms are governed by your plan’s documents. The IRS requires repayment of the loan within five years, but loans taken to purchase your principal residence may be repaid over a longer period. 401(k) loans offer you the unique ability to “put the money back” into your retirement account. Additionally, any interest paid on the loan will go into your account balance.
All that said, we look at withdrawing any funds from any retirement accounts as a last resort. Once the money is withdrawn and spent, it almost impossible to catch up to where you were. There is an opportunity cost to missing out on tax-deferred or tax-free growth of funds that were designated for retirement.
If you have questions regarding your retirement savings, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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