You may be able to use your Roth IRA to fund a home purchase. Here are the pros and cons

A Roth individual retirement account is often cited as a way to save for your golden years. It could  also help you buy a house.

In a nutshell, up to $10,000 in earnings can be withdrawn from such an account — free of both taxes and penalty — for a home purchase if you meet certain requirements. That’s on top of the ability to withdraw your direct contributions at any time, because you already paid taxes on that money.

As home prices continue their upward trajectory, the amount of cash needed to purchase one continues to rise as well. While it’s possible to buy a house with less than 20% down — the average is 12% overall and 6% for first-time buyers — going that route also might mean paying private mortgage insurance, or PMI, until your equity is at least 20% of the home’s value. PMI can run $30 to $70 monthly for each $100,000 borrowed, according to Freddie Mac.

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For a $250,000 house, a 6% down payment would be $15,000. At 20%, it would be $50,000. Those amounts don’t include other costs related to closing on the purchase, such as transfer taxes or points (one point is equal to 1% of the mortgage). 

At the same time, the cost of borrowing is relatively cheap due to historically low interest rates. The average rate on a conventional 30-year mortgage was just under 3% on July 31, according to NerdWallet.com.

Nevertheless, using Roth IRA money to buy a house is not a strategy that makes sense for everyone. Here’s what to consider.

With a Roth IRA, your contributions are made after-tax. This means you can withdraw that money at any time without penalty. The 2020 contribution limit is $6,000 ($7,000 if you are age 50 or older). To make contributions at all, though, your modified adjusted gross income can’t be above a certain amount.

To contribute the maximum, that limit is $124,000 if your tax filing status is single, and $196,000 for married couples who file jointly. Above those income amounts, the contribution limit is reduced until completely phasing out at income of $139,000 for single tax filers and $206,000 for married couples filing jointly.

While those contributions are yours whenever you want them, the same can’t be said for the growth in the account. Unless you meet an exclusion — such as reaching age 59½ and having owned a Roth IRA for at least five years — withdrawing earnings will generate taxes and a 10% penalty.

Another exclusion from the 10% penalty is when the earnings are used for a qualified first-time home purchase. However, to avoid taxes on the earnings, you must have held the Roth IRA for at least five years (with some exceptions related to the timing of contributions).

For Roth conversions — that is, money moved from another retirement account to a Roth IRA — you generally must hold the account for five years if you’re under age 59½ to avoid the 10% penalty on any withdrawals (unless you meet the first-time-home-buyer exclusion).

The qualified home purchase is for first-time home buyers or people who haven’t owned a house as their primary residence in at least two years. The buyer can be you, your spouse or one of your family members.

The withdrawal also must be used within 120 days of the distribution and be used to pay for expenses related directly to the home purchase, such as a down payment or other closing costs. And, the $10,000 earnings exclusion is a lifetime limit.

Be aware that traditional IRAs also come with the penalty-free exclusion for qualified home purchases. However, the $10,000 limit is applied to the entire withdrawal, said certified financial planner and CPA Jeffrey Levine, director of advanced planning at Buckingham Wealth Partners in Long Island, New York. And, you’d generally pay taxes on the money.

The flexibility of a Roth might make it a good place to save up to buy a house down the road, some advisors say. 

“We’ve long suggested that young people use a Roth IRA to save the considerable amount needed for a first-time home purchase,” said CFP Daniel Galli, principal of Daniel J. Galli & Associates in Norwell, Massachusetts.

“As long as we can meet the five-year rule, they can use all contributions plus up to $10,000 of gain, free of tax and penalty,” Galli said. 

However, he said that he has recommended this strategy to young workers who also are saving for retirement through a 401(k) plan at work.

Additionally, he said, there can be risk involved, depending on how aggressively you invest the money in the Roth IRA.

“This strategy requires some market risk in order to enjoy some gains, but the rewards can balance that,” Galli said.

If you do go this route, the amount of risk you should take on in your portfolio depends partly on how long until you need the money, said Levine at Buckingham Wealth Partners. If you’re planning for something 10 years out, he said, you could start out aggressively invested in stocks and gradually reduce your exposure.

“You might want to make it more conservative over time,” Levine said.

If you already have money in a Roth IRA and are now eyeing it as a way to fund a home purchase, be aware that many financial advisors caution against using that money if it was earmarked for retirement.

“These accounts are designed to help people accumulate as much money as possible for retirement,” said CFP Shon Anderson, president of Anderson Financial Strategies in Dayton, Ohio.

“You can obtain a loan for a home, car, business venture, college tuition … but no one will ever receive a loan to retire,” Anderson said.

However, depending on your situation — i.e., how much you’d be withdrawing, whether you have sufficient retirement savings elsewhere, if you can otherwise afford the house payments and costs of homeownership — using the Roth money for a house might make sense.

“If the person is contributing to a 401(k), getting a decent match, they’re on a good track for retirement and the Roth is just a nice addition, I might consider it,” Galli said.

“But if their only retirement savings is the Roth and they’re, say, in their 40s, I probably wouldn’t,” he said.