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Tap IRA to help child buy a home

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in Small Business Tax

Suppose your recently graduated child is looking to buy a starter home. You’d like to help out but you don’t have enough liquidity.

Strategy: Take some money out of your IRA. Although the distribution is taxable, you can avoid the usual 10% early withdrawal penalty if the funds are used for qualified first-time homebuyer expenses.

The maximum withdrawal allowed is $10,000, ($20,000 if a married couple separately withdraws $10,000 from their own IRAs).

Here’s the whole story: Normally, if you receive a distribution from an IRA prior to age 59½, you must pay a 10% tax penalty, in addition to the regular income tax you owe. The 10% penalty is assessed on the taxable portion of the distribution (i.e., the pro rata amount representing deductible contributions and accumulated account earnings).

However, there are several key exceptions to this rule, including one for the first $10,000 of funds received by first-time homebuyers. The definition of a “first-time homebuyer” for this purpose is quite broad. It includes an individual who hasn’t owned a home as his or her principal residence for the past two years.  

Also, note that the homebuyer doesn’t have to be the same person as the IRA participant. For instance, if the situation dictates, you can use IRA funds to help purchase a home for your children, your grandchildren or your parents.

To qualify for the exception for first-time homebuyers, you must meet the following requirements.

  • The distribution must be used to pay qualified acquisition costs within 120 days after the day you receive it.
  • The distribution must be used to pay qualified expenses for the principal residence of the first-time homebuyer. Qualified expenses include acquisition costs (e.g., the down payment), the cost of building or rebuilding the home and any usual or reasonable settlement, financing or closing costs.
  • You can’t have withdrawn $10,000 previously for a first-time home purchase.

The same rules apply to early withdrawals from a Roth IRA.

Tip: Remember that retirement saving is the primary focus of IRAs. When possible, replenish your account.

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