Borrowing against Roth IRA

[Guest SPollock]

I have a client who transferred assets from a Traditional IRA to a Roth IRA prior to December 31, 1998. He is presently single but will be getting married in the very near future. He transferred the money to the Roth IRA so he could have access to the funds for a down payment on the purchase of his first home. His future wife has an existing home. QUESTION #1: If he puts his name on the title of his future wifes home (after they are married) will he still be able to access the money is his Roth IRA to purchase a home? (He plans to make this purchase in five years if that matters.) QUESTION #2: Can you "borrow" against a Roth IRA, or is it considered a distribution and how is it taxed or penalized?

Thanks for the help!!

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[John Olsen]

He can still access the money in the Roth to buy the home, but the earnings will NOT be exempt from the 72(t) penalty, by reason of the "first time homebuyers's" exception (because he will have been an owner of a principal residence within 2 yrs of buying the new home [assuming that the new home is bought within that time]).

You cannot borrrow against or from ANY type of IRA. It's a "prohibited transaction" and causes immediate disqualification of IRA and recognition of income.

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John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

[Bruce Steiner]

If they weren't getting married, his IRA could make a loan to her.

We've had a number of cases in which IRAs have invested in private investments. You have to be *very* careful to avoid both the prohibited transaction rules and the unrelated business taxable income rules.

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

[Guest SPollock]

Thank you both for your excellent information. QUESTION: What if after they get married, he does NOT put his name on the home; could he then borrow from his Roth IRA to purchase a home and NOT pay the penalties?

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[John G]

I hope you explained to your client how using a Roth for a house purchase could very well be the biggest financial mistake he might make. The true value of a tax shelter comes with the passage of time. Some alternatives: (1) use the equity in the fiances house, (2) buying something less expensive, (3) waiting a few years until they build up additional cash, (4) asking for some help from relatives such as a loan from Mom&Dad who probably have some money siting in CDs earning 5%, and (5) putting less down in this era of very low mortgage rates.

Roth assets should not be looked at like other assets. They are special. Your client may not be able to fund a Roth in future years. I would be very very reluctant to tap this extraordinary tax shelter to own a home.

[Guest Lyric]

Am I right in suggesting that SPollock's client would not be able to "borrow" from his Roth to purchase a house? Wouldn't this be merely an early withdrawal allowed under certain conditions (including the purchase of a first house). The money could not be reimbursed to the Roth account, and is therefore not a loan.

I expect there are situations in which it might make sense to use Roth assets for the downpayment on a house, but I agree that long-term tax-free compounding is the real virtue of the Roth, and that it is best to leave it alone to do its thing.

I have a similar question regarding the client not putting his name on his future wife's house. My husband owns a house which is not in my name at all, and was bought before our marriage. If, at some point, I wish to buy a house of my own (we are in the process of getting divorced), would I be regarded as a first-time homebuyer?

[John Olsen]

You may NOT "borrow" from your own IRA - EVER, for ANY reason!

DISTRIBUTIONS made from an IRA are subject to various tax rules, including some EXCEPTIONS TO THE 10% 72(t) PENALTY which turn on the use of the money distributed [rather like "tracing rules"].

The "qualified first-time homebuyer's" exception is one of these.

Not incidentally, the respondent who observed that using the Roth IRA to purchase a home COULD be a big mistake makes a good point. You cannot "repay" that distribution. You've lost the opportunity for tax deferred - and, eventually, tax FREE - growth of that money.

That said, if the Roth distribution is the only way you can get the home, maybe it makes sense. Like everything else, it's a tradeoff.

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John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

[John G]

Olsen is absolutely correct. I went back and looked at my response and realized that I forgot to respond to the particular issue of borrowing. But, I hope readers will think long and hard about why they opened the Roth to begin with. Early withdrawals for any reason tend to be long term dumb.