The penalty-free withdrawal under the IRA homebuyer's exemption is only significant for those under age 59½.
If you're over 59½, you can withdraw IRA assets for a home down payment—or any reason—penalty free. However, unless you have a Roth IRA, you're still subject to having to pay income taxes on contributions and any earnings withdrawn.
The real question about using IRA assets to purchase a home has to do with big-picture retirement planning. Careful analysis is essential.
My wife and I are both over 63 and want to purchase a primary residence for our retirement. Can we use money from our IRA for the down payment? If so, are there any tax issues? —A Reader
It's great that you and your wife are thinking ahead about where you'll live in retirement. We often focus on how much money it will take to retire comfortably, but where you'll actually call home in retirement is something that a lot of people don't consider in advance. And I'm happy that you bring up the possibility of using some of your IRA assets for a down payment on a new home because it raises a lot of related issues that you'll also want to think about now.
But first, let's talk about IRA rules because it seems from your question that you may be thinking about exemptions for first-time home buyers that really are only pertinent for folks under age 59½.
How the homebuyer exemption works
As you're probably aware, taking a distribution from an IRA before age 59½ triggers both income taxes and a 10 percent penalty. There are a few exceptions that allow you to avoid the penalty and one of those is using IRA money for the purchase of a first home.
Interestingly, the definition of first home goes beyond your very first purchase. It also applies if you haven't owned a principal residence at any time during the past two years. The catch is that the maximum penalty-free withdrawal from an IRA under the homebuyer exemption is a lifetime limit of $10,000—which doesn't go very far in many housing markets these days. However, the $10,000 limit applies to the IRA owner, so if you and a spouse each had an IRA, each of you could withdraw $10,000 from your own IRA as first time homebuyers without incurring the 10% early withdrawal penalty.
However, because you and your wife are both 63, this exemption isn’t relevant or necessary. At your age, you can withdraw any amount from your IRA penalty free. For you the issues are taxes and overall financial planning.
Taxes you may have to pay
When it comes to using IRA money for a home purchase, there's no exemption from income taxes. So whether or not you'll have to pay taxes on a distribution—for any reason—depends on the type of IRA you have.
With a traditional IRA, withdrawals are subject to ordinary income tax no matter what. So let's say you withdraw $50,000 from your traditional, deductible IRA for a down payment. That $50,000 would be added to your taxable income for the year. If you're in the 25 percent tax bracket, your tax liability could be $12,500.
A Roth IRA is a different story. After age 59½, withdrawals of earnings from a Roth are tax-free, as long as you've held the account for five years. So if you and your wife have qualifying Roth IRAs, you could pull money out of your accounts and use it for your home purchase tax-free. In fact, withdrawals of contributions from a Roth IRA can be withdrawn at any age without tax consequence since they are always made after-tax.
The bigger question—your overall retirement budget
Taxes aside, to me the bigger question is how using IRA money for a down payment will affect your overall retirement security. And here's where you have to do some detailed planning, because with more and more people living into their 90s, retirement can last a very long time.
First, you’ll want to look carefully at your sources of retirement income. This would include your savings, Social Security, pensions, rental income—anything that you consider to be reliable. Then take a realistic look at your estimated expenses in retirement. Since you’re considering a home purchase, I suggest creating a detailed budget focusing on how much you can afford for housing. And, remember, it’s not just about a potential mortgage. You also need to factor in property taxes, upkeep, homeowners’ insurance, and potentially homeowners’ association fees.
Will your income cover all these costs? And how much will you need to draw from your savings to make it all work? Initially, you may want to limit your annual withdrawal from your savings to approximately 4 percent of your assets assuming you increase this with inflation each year to make sure you don’t outlive your money.
Now with those numbers in front of you, consider how much of your IRA you could afford to put toward a down payment without jeopardizing your future financial security. If you take a big chunk out now for a down payment—plus pay the potential taxes on your withdrawal—will you have enough left in your savings to feel secure? Remember to also factor in the loss of future growth on any IRA money you put toward a home purchase.
Talk to your financial advisor
At this point, I recommend that you talk to your accountant or financial advisor. Run some retirement scenarios. Ultimately, how you use your IRA assets is up to you. Just make sure you not only feel confident using some of this money for a home down payment now, but also that you can maintain a comfortable retirement for many years to come.