As a young professional, there are many worthy financial goals competing for your paycheck dollars, including saving for retirement and buying your first home. If you’re aiming to do both, there’s a chance you’ll have to sacrifice one for the other at some point—especially if you’re paying back student loans.
On one hand, the earlier you start saving for retirement, the longer your money has to grow. On the other hand, saving for a down payment on a home in today’s market can take years—and the longer you wait, the more you’ll need. But there’s one tool that can help you save for both, without having to plan your whole life before you turn 30: A Roth IRA.
While you’ve probably been told you should never tap into your retirement money, using cash from a Roth IRA to fast-track your dream of home ownership could be a worthy exception to that good advice.
Here’s why and how to leverage a Roth IRA to become a first-time homeowner without having to delay your retirement goals.
The Low-Down on a Roth IRA
A Roth IRA is different from other retirement accounts. The main distinction is that you contribute after-tax dollars to a Roth IRA because contributions are not tax deductible.
Therefore, the distributions you take when you retire are not taxed. Compare that to traditional IRAs where you reap the tax benefits now (your contributions are deducted from your income on your tax return), but have to pay taxes on the money you withdraw during retirement.
But here’s the real game-changer: Unlike a traditional IRA, you can withdraw the money you contributed to a Roth IRA at any time without penalty. Where things get tricky is when it comes to your investment earnings.
In very specific instances—buying your first home, for one—you are allowed to withdraw up to $10,000 of investment earnings from a Roth IRA with no tax or penalty. The only stipulations are that you must have had the account open for five years, and that the withdrawal is for your very first home.
By comparison, if you wanted to withdraw money from your 401(k) or a traditional IRA, you would pay taxes and a steep penalty.
Crunch the Numbers
The best way to explain how this all works is by running the numbers. Let’s say you open a Roth IRA in 2017, contribute $5,500 per year (the current maximum contribution allowed) for five years, and earn 7% per year on that money.
You’d have made $27,500 in contributions and earned about $6,300 on your investment by 2022. If you keep going another two years, your contributions would climb to $38,500 and the investment earnings would be around $12,400.
After five years, you can withdraw all of your contributions and up to $10,000 of your investment earnings—but you might not have earned that much yet. Because this benefit is only available once in a lifetime, ideally, you might want to time it so that you tap into your Roth after you’ve earned the full amount allowable.
One other important to-know: Roth IRAs do have contribution limits based on your income. For example, if you are single and make less than $118,000 in 2017, the maximum Roth IRA contribution is $5,500, even if you participate in a retirement plan through your employer.
If you make more than that, the amount you may contribute is reduced and disappears completely if you make $133,000 or more. For more information about IRA accounts and contribution, check out our IRA calculator.
Making This Strategy Work for You
In a perfect scenario, you wouldn’t choose to become a homeowner at the expense of draining your retirement nest egg. Instead, you’d open a Roth IRA and treat it almost like a savings account, with the intention of using it for your first home purchase five years (or more) from now.
Unlike a savings account, however, your investment returns are tax free, and—contrary to other retirement products—you wouldn’t even be taxed when it comes time to withdraw.
Ideally, at the same time, you’d continue to fund another retirement source, such as one offered through your employer. Even though home ownership is your immediate goal, you don’t want to totally neglect your retirement.
And what if you don’t end up buying a home, or you come up with another source of down payment? A Roth IRA is still a win, since you can leave that money be and let it continue to grow for your retirement.
There are a few other circumstances in which you can avoid penalties on a withdrawal, such as for a qualified higher education expense, certain medical costs, and other hardships. Be sure to consult with your tax professional to clarify any of these exceptions before you move forward.
For most young adults with other financial obligations and an early career-level salary, using a Roth IRA to help with a down payment will require an examination of personal priorities.
Only you, in consultation with a financial expert, can determine if it’s a tradeoff you’re willing to make. Schedule an appointment with our advisors to help you define your goals and think through a strategy that works for you.
SoFi can’t guarantee future financial performance.
This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.
Advisory services offered through SoFi Wealth, LLC, a registered investment advisor.
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