First time home buyers

[Guest rich]

I have a couple questions. 1 - I understand that you may withdrawl from your Roth IRA without penalty for a first time home purchase. Does this mean the original contributions and earned income or just contributions or just income? 2 - Thoughts if this is a good way to save in the short term for a house since the income is tax-free?

[Guest Mark L]

Rich;

Answers to your questions:

1. Annual contributions to a Roth IRA can be withdrawn at any time without income tax or penalty consequences. You have already paid the tax and the early distribution penalty is only applicable to taxable distributions.

Distribution of 1998 conversions

taxable under the 4 year ratable spread would be subject to penalty if they are paid prior to the end of such 4 year period

and if the IRA owner is under 59 1/2. However, the penalty would be avoided if the distribution qualified under the first time homebuyer exclusion.

Roth IRA earnings withdrawn

prior to both your account being

in existence for 5 taxable years and your attainment of age

59 1/2 will be subject to tax

and penalty. However, if you indeed qualify for the first time

homebuyer exemption, there will be no penalty, only the tax.

2. I can't buy into the theory that

this is an especially good way to to save for a house. The number one purpose of the Roth IRA should be to generate

substantial tax-free wealth over a long period of time. Invasion against the capital build up doesn't help in that regard.

Secondly, the lifetime cap on this exemption is $10,000 per individual which is not overly excessive. Lastly, unless you plan on waiting until attainment of age 59 1/2, your distributions will only be tax-free to the extent that you receive funds on which you have already paid the tax! (i.e. the return of your own contributions.) You can't withdraw earnings tax-free before this time.

Rich, I hope this helps. Good luck.

[Guest Mark L]

Rich;

One correction to my earlier message.

The withdrawal of funds converted from a traditional IRA in 1998 being paid under the 4 year schedule will be subject to the early distribution penalty if the distribution occurs within 5 years of the year of the conversion and you are under age 59 1/2. The four year tax payment period is not the one used to measure whether or not the penalty applies. It is the 5 year period mentioned above.

As stated earlier, exemption to the penalty will apply if the distribution qualifies for first time homebuyer purposes.

[Guest danmar]

Actually, Roth earnings are tax-free if distributed when the account is at least 5 years old and due to one of 4 special purposes:

*owner over age 59 1/2

*owner qualifies as a first-time home buyer ($10,000 limit applies to earnings )

*due to the owner's death

*due to the owner's disability.

So, distributions of Roth earnings after 5 years for a first time home purchase will be tax-free and penalty free.

I think this can be an important niche planning tool. Consider a working 20 year old who wants to buy a house in 5 years and has no concept of retirement planning. Parents may choose to gift $2000/yr to her to invest in a Roth. At age 25, it may be worth $15,000. Then, she buys a first home. $10,000 comes out tax-free as a return of principal. The remaining $5000 is earnings and is withdrawn tax free due to the qualifying first time home purchase. Not a bad way to do it.

Check out Fairmark's discussion of Roth distributions

[Guest Mark L]

danmar;

Good catch on the Roth earnings distribution rule. I was thinking of the education expense exemption.

Thanks.

[Guest el-jefe-91]

My wife and I are building a house (we are both first-time home buyers) and it is going to be completed 3 months earlier than predicted. We are going to need $15,000 in additional funds to close. We converted both of our IRAs to Roth in the first year it was available (I think it is short of the 5-year rule). What will happen if I try to use up to $10,000 from these IRAs? Would reconverting to a traditional IRA help us to avoid panalties (haven't we already paid taxes on the money at conversion?)?

We have not made much and the net asset values on the accounts are barely over $10k for each. WHile I understand that this does not make sense from a long-term inveting standpoint it is a quality of life issue. Can anyone help me?

[John G]

You did not indicate your other assets or income, but I am going to assume you are in the early stages of your career.

I would suggest you look to other sources to solve this problem. It is not easy to get money back into a tax shelter once you have taken it out. The Roth is your absolutely last resort.

First, consider internal family financing. Can you think of any relative complaining about the rates on CDs? You could probably handle a five year loan and offer a rate 3% above the going CD. Do a senior a favor! If that is not possible, start talking with your banker. If your credit rating is in good shape, you should be able to find some short term mechanism.

That the Roth has not changed much in value is not relavent. That is just market history for the last two years. What is more important is that you could have many decades of tax shelter and that trumps the short term financial hurtle from my perspective.