Is a Roth IRA for a Home Down Payment a Good Idea or a Bad Idea?

Believe it or not, you're able to take money out of your individual retirement account for any reason at any age -- the Internal Revenue Service just discourages it with potential taxes and penalties. Though your Roth IRA might look like a big cash pot that you can use for a home down payment, make sure you know the drawbacks before cashing out your nest egg.

No Qualified Withdrawal Taxes

You can withdraw your contributions from a Roth at any time without tax or penalty, since you paid taxes on the money before you contributed it. The only issue surrounds your earnings. If you're over 59 1/2 and you've had a Roth IRA for at least five years, you can take out all the money you want, including earnings, penalty free from your account, although you will have to pay income taxes on the earnings. If you're not quite 59 1/2 yet, but you've had a Roth IRA open for at least five years, you can take out up to $10,000 in earnings penalty free if you qualify as a first-time home buyer. To qualify, you can't have owned a home for the past two years and, if you're married, your spouse also has to qualify.

Contributions Always Distributed Tax-Free

Even if you're not able to get a qualified distribution, for example because you're not 59 1/2 or a first-time home buyer, you can still take out all your contributions without paying any taxes or early withdrawal penalties. As far as the IRS is concerned, your contributions come out of the account before any earnings. So suppose you have $50,000 of contributions in your Roth IRA. You can take out that entire $50,000 without paying any taxes or penalties because you didn't get any tax breaks for making contributions to the account. Only then do you begin to draw from the earnings.

Early Withdrawal Penalties

If you use up all your contributions and then take out earnings, the earnings are taxable and hit with a 10 percent early withdrawal penalty. For example, if you took out the $50,000 in contributions, and then $3,000 of earnings, you would have to pay income taxes on the $3,000 plus a $300 penalty. On the bright side, if your Roth IRA hasn't been open five years, but you meet the requirements to be a first-time home buyer, you can avoid the penalty, but not the taxes, on up to $10,000 of early earnings withdrawals.

Depleting Your Nest Egg

Any time you take money out of your retirement plans, including a Roth IRA, for something other than retirement expenses, use caution. Once you take the money out, you're giving up the tax-free growth indefinitely. You can't "make up" the difference by putting those contributions back in, should you have a windfall, and so there's no way to make up for lost time to rebuild your nest egg. However, as with any financial decision, there's a balance of cost and benefit to consider. For example, if buying the home using funds from your Roth means you have to pay less for housing in retirement, it might be the right move for you.

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About the Author

Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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