Because IRAs are intended to help you save for retirement, the Internal Revenue Service (IRS) doesn’t want you to withdraw any funds from them before you turn 59½—and to enforce that, it charges a 10% penalty on the amount withdrawn... plus income tax. However, every rule has its exceptions. It’s possible to use funds from an IRA, penalty free, to buy a house, even if you are not 59 1/2 years old yet.
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Who Qualifies for the IRA Exemption?
In order to use money from your IRA plan to purchse a house, you must be a first-time home buyer. The IRS defines that status rather loosely. You are considered a first-timer if you (or your spouse) haven’t owned a home at any point during the last two years. So even if you possessed a principal residence
at some point in the past, you may well meet the first-time-buyer requirement. The key word, by the way, is “principal.” If you’ve owned a vacation home or taken part in a time-share during the last two years, the exemption can still apply.
Also, you yourself don’t have to be the one shopping around. You can tap into your IRA and qualify for the exemption if the money is to aid your spouse, child, grandchild, or parent buy their home.This still stands even if you are a current homeowner.
The Traditional IRA Exemption
If you qualify as a first-time home buyer, you can withdraw up to $10,000 from your traditional IRA to help cover the costs of buying a home. Your spouse can also withdraw up to $10,000 from their IRA. Even though you’ll avoid the 10% early withdrawal penalty on this money, you’ll still owe income tax on any amount you (and your spouse) withdraw. Also, that $10,000 is a lifetime limit. You won’t get to use the first-time home buyer provision again to buy a home, even if you use a different IRA.
Tap Your 401(k) Instead
If you have a 401(k), you might think about taking a loan from that account instead of withdrawing money from your IRA. In general, you can borrow up to 50% of your 401(k) balance—up to a maximum of $50,000—for any reason without incurring taxes or penalties. You’ll pay interest on the loan, typically the prime rate plus one or two percentage points, which will go back into your 401(k) account. In most cases you have to repay the loan within five years, but if you’re using the money for a house, the repayment schedule may be extended to as many as 15 years.