Down Payment Alternative: Pulling from Retirement Account
Philadelphia Mortgage Brokers
Philadelphia Mortgage Brokers Pennsylvania
Published on April 28, 2022
retirement money in a jar with calculator

Down Payment Alternative: Pulling from Retirement Account

Not everyone has a sizable bank account when they are buying a home. Maybe it’s your first purchase and you haven’t saved much yet. Perhaps you are a seasoned investor and your funds are tied to your properties. There are options for making a down payment on a home purchase. Most buyers have heard of gift funds, down payment assistance programs, and low-down payment programs such as FHA. Did you know you can also pull funds from your retirement account to help with a down payment? Let’s look at 5 types of retirement accounts and what is generally involved when borrowing from them including tax implications, repayment plans, and penalties.

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1. Conventional IRA

When you take money out of a conventional IRA, you’ll generally need to pay income taxes on the funds. For example, assume you want to withdraw $50,000 out of your conventional IRA and your income tax bracket is 22%. You would be required to pay $11,000 in taxes on that withdrawal. If you don’t have the $11,000 sitting around, you would “gross-up” your withdrawal and pay the taxes out of your retirement account: ($50,000 / 78% = $64,103). In this case, you’d need to withdraw $64,103 from the account, pay $14,103 in taxes (22% of the withdrawal), and walk away with net proceeds of $50,000 after-tax.

If you withdraw the money prior to age 59.5, you’d also need to pay a 10% early withdrawal penalty: ($50,000 / 68% = $73,529). In this case, you’d need to withdraw $73,529 from the account, pay $23,529 in taxes and penalties (22% taxes + 10% penalty = 32% of the withdrawal), and walk away with net proceeds of $50,000 after-tax.

As you can see, it could get very expensive to pull money out of your retirement account! There could be some exceptions to the early-withdrawal penalty, such as if you’re withdrawing up to $10,000 to purchase your first home.

2. Roth IRA

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When you take money out of a Roth IRA, you generally won’t need to pay taxes on the withdrawal. However, if you withdraw the money prior to age 59.5, you’ll probably need to pay a 10% early withdrawal penalty. Again, there could be some exceptions to the early-withdrawal penalty, such as if you’re withdrawing up to $10,000 to purchase your first home.

3. Inherited IRA

The same rules as outlined above apply when you take money out of an inherited IRA, with the exception being that you likely won’t need to pay the early withdrawal penalty. If you inherit a conventional IRA, you’ll generally need to pay income taxes on the funds when you withdraw them. If you inherit a Roth IRA, you generally won’t need to pay income taxes on the funds when you withdraw them.

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4. 401 (k)

If you withdraw funds from a conventional 401(k), you’ll generally need to pay income taxes when you withdraw the funds. If you withdraw funds from a Roth 401(k), you generally won’t need to pay income taxes when you withdraw the funds. In either case, if you withdraw the funds prior to age 59.5, you’ll need to pay a 10% early withdrawal penalty.

There is no first-time homebuyer exception to the early withdrawal penalty with 401(k) plans. However, some plans allow you to take out a loan against the value of the plan. This could be dangerous though because you’d be required to pay back the loan in full if you lose your job, or you’d risk being required to pay taxes and penalties as though it was a full withdrawal.

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5. 72 (t) Exception

There may be an exception to the 10% early withdrawal penalty if you are in a hardship situation. CLICK HERE to view details from the IRS website on how that exception works.

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Be sure to check with a CPA for details about how these general rules apply in your specific situation. Contact me if you need a referral!

PLEASE NOTE: THIS ARTICLE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE THE IRS RULES REGARDING RETIREMENT PLANS.

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