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Roth IRA > Strategies

Saving for a Home

Using a Roth IRA to save for a home.

There are two different ways to use the Roth IRA if you're saving for a home. Neither one works for all people, but if you find a good fit with either one of these you can save on taxes at the same time you're saving for a home. The two plans are:

  • The five-year plan. You qualify as a first time homebuyer and you don't intend to purchase before 2003.
  • Combined savings. You're setting some money aside for retirement at the same time you're saving for the purchase of a home. This plan can provide benefits even if you don't meet the requirements for the five-year plan.

Five-Year Plan

The Roth IRA provides a special benefit for people meeting two requirements:

  • They're saving for a home purchase that is at least five years away, and
  • They qualify as a first time homebuyer (which includes some people who previously owned a home).

If you meet these two requirements, you can withdraw earnings from your Roth IRA before age 59 without paying any tax or penalty on the earnings. Getting to use all your earnings tax-free is a nice boost to your home purchase!

Five-Year Test

The five-year test can actually be satisfied in less than four years, depending on when you establish your IRA. The rule is that you must not take the earnings before the first day of the fifth taxable year after the year you started your Roth IRA. For Roth IRAs that are started in 2000, for example, that means your home purchase shouldn't occur before 2005. Note, however, you can establish a Roth IRA for 2000 any time up to April 15, 2001 and still qualify for a home purchase in January, 2005, less than four years away.

First-Time Homebuyer Test

To avoid paying tax on a distribution of earnings from your Roth IRA, you must meet the first-time home-buyer test as well as the five-year test. To have a qualified first-time homebuyer distribution, you need to meet all of the following requirements:

  • The purchase must be a principal residence.
  • The person using it as a principal residence must be the owner of the IRA or a family member (within limits).
  • The person using it as a principal residence must be a "first-time homebuyer" (generally someone who hasn't owned a home in the previous two years).
  • The purchase must cover "qualified acquisition costs."
  • The owner of the IRA may not treat more than $10,000 as qualified first-time homebuyer distributions (a lifetime limitation).
  • The purchase must be made within the applicable time limit.

For details on these requirements see First-Time Homebuyer.

Combined Savings

There's another strategy in using the Roth IRA to save for a home. This strategy works when you're saving for retirement and for some other purpose at the same time. The idea is to take advantage of the fact that you can withdraw your contributions from a Roth IRA without paying tax or penalties. If you combine your retirement savings and your home purchase savings in a Roth IRA, you may be able to withdraw the entire amount of your home purchase savings without paying tax or penalty. For more detailed discussion of the combined savings strategy see Roth IRA and College Savings.

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