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Can I use my IRA toward buying a home?

Q: I want to buy a house, but I'm afraid I won't have enough money. I have a money market IRA I could put toward it, but I am not yet 59 1/2. What costs should I expect?

A: It might be helpful to look at this question two ways: First, in terms of the tax implications of using money from an individual retirement account (IRA) toward a house and, second, in terms of substituting equity in a home for retirement savings.

Tax implications of a traditional IRA vs. Roth IRA

You are right to identify the age of 59 1/2 as key to making decisions about using money from an IRA. Normally, IRA distributions before that age would require you to pay a 10 percent penalty for taking the money out early. However, there is an exemption of $10,000 for first-time home buyers. So, if this is your first time buying a home, you may be able to use $10,000 from your IRA toward it without penalty.

The next thing to consider is whether the money you take out of the IRA will be impacted by ordinary income taxes. Here, the key consideration is whether the IRA is a traditional or a Roth IRA.

With a traditional IRA, the contributions you made to the account were tax-deductible, so money is taxed when you take it out.

With a Roth IRA, though, you will have paid taxes already on money going into the account. As a result, distributions would not be subject to ordinary income taxes if you have had the IRA for at least five years. However, the $10,000 home buyer exemption also applies in this situation, so you should be in the clear if that is the case.

The above are just some general guidelines. Tax implications can depend greatly on the details of each person's individual situation. So you may want to consult with someone about how the rules will apply in your case.

Home equity vs. retirement savings

The move you are contemplating substitutes one form of wealth for another -- you would be gaining some home equity and losing some retirement savings. Be sure to consider the long-term implications of this switch, both in terms of keeping up with mortgage payments and retirement planning.

Obviously, the $10,000 IRA early withdrawal exemption you might be able to put toward a house would help with the down payment, but this would still leave you with a mortgage to pay. You need to look at what the mortgage payment schedule would be and how this would fit within your budget. Longer-term, this would mean $10,000 less in retirement savings. Going forward, can your plan of saving for retirement make up for that reduction? Keep in mind that home equity won't necessarily help you pay your monthly bills, now or in the future.

The tax rules are clearly written to allow some leeway for using IRA savings toward buying a home. Just be sure you fully understand how those rules would apply to your situation and how you would manage your finances after making such a move.

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