Alternatives To Tapping Your 401
If you must tap into retirement savings, it’s better to look at your other accounts firstspecifically IRAsespecially if you’re buying a first home .
Unlike 401s, IRAs have special provisions for first-time homebuyerspeople who haven’t owned a primary residence in the last two years, according to the IRS.
First, look to take a distribution from your IRAif you have one. You may be able to withdraw IRA contributions without penalty due to a qualified financial hardship. You can also withdraw up to $10,000 of earnings tax-free if the money is used for a first-time home purchase. As a first-time homebuyer, you can take a $10,000 distribution without owing the 10% tax penalty, although that $10,000 would be added to your federal and state income taxes. If you take a distribution larger than $10,000, a 10% penalty would be applied to the additional distribution amount. It also would be added to your income taxes.
Can You Use A 401 To Buy A House
Before you quickly search up 401k first time home buyer, heres the answer: If youre a first-time home buyer, and your employer plan allows it, you can use your 401 to help buy a house. There are a couple of ways to access the funds.
First, its possible for a first-time homebuyer to take a loan from an existing 401. Your employer generally sets the rules for 401 loans, but you typically must pay back the loan, with interest, within five years. You pay yourself interest to help offset the loss of investment growth, since the funds are no longer invested in the market.
You can take out a 401 loan for a few different reasons , depending on your plans policies. Those using a loan to purchase a residence may have more time to pay back the loan.
In certain rare circumstances, in the case of an immediate and heavy financial need, the IRS will allow you to make a 401 hardship withdrawal to purchase a primary residence. Hardship withdrawals do not cover mortgage payments, but using a 401 for a down payment for a first-time home buyer could be allowed.
The IRS has very strict rules for qualifying for a hardship withdrawal . And if you dont meet them, the funds you withdraw will be subject to income tax and a 10% early withdrawal penalty.
Can You Claim A Hardship Withdrawal
The IRS permits hardship withdrawals from 401 accounts for several reasons, and among them is a purchase of a primary home. You must pay a 10 percent penalty on the withdrawn amount if you’re under age 59 ½, which means if youre withdrawing $10,000, youll pay $1,000 of that in penalties. Once you receive your hardship withdrawal to buy your house, you cant put any more money into your 401 for at least six months. While youll receive more money in your paycheck since your contributions arent automatically withheld during this period, that extra money is also taxed, which is not the case when its placed in a 401 until you start making retirement withdrawals, presumably years down the road. One caveat: Not every employer-sponsored 401 retirement plan permits hardship distributions.
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Withdrawing Money From A Roth Ira
Using a Roth IRA to help buy a first home can be a smart alternative to borrowing from a 401 that might be beneficial for some home buyers. Unlike 401s, Roth IRA contributions are made with after-tax dollars.
Contributions can be withdrawn at any time, tax free earnings can be withdrawn without a penalty at age 59½ or older, as long as youve held the account for at least five years.
If youre under 59½ or dont meet the five-year criteria, some exceptions may apply for a first-time home purchase.
After the account has been open for five years, Roth IRA account holders who are buying their first home are allowed to withdraw up to $10,000 in investment earnings with no taxes or penalties. The $10,000 is a lifetime limit.
Roth IRA funds can be used to help with the purchase of a first home not only for the account holders themselves, but for their children, parents, or grandchildren.One important requirement to note is that time is of the essence when using a Roth IRA to purchase a first home: The funds have to be used within 120 days of the withdrawal.
Using Retirement Plan Assets For A First
First-time home-buyers are often surprised by the requirements of obtaining a mortgage, especially when it comes to your down payment. One way you can improve your chances of getting a home loan is by putting at least 20% down at the time of purchase. For existing homeowners like me, coming up with a 20% down payment usually starts with selling the home Im in right now and using the equity to make a down payment on my next home.
But what about someone that may be buying a home for the first time? Coming up with a $50k down payment on a $250k home may take several years of aggressive saving, but your retirement account may not be a bad place to go for the additional funds needed to get you on the path to home ownership. In fact, the IRS offers certain breaks for taxpayers that choose to use retirement assets to purchase a first home.
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Can I Use My 401 To Buy A House
For many would-be homeowners, the down payment is the biggest entry barrier to buying a house. While down payments can be as low as 3.5%, 20% is ideal if you want to secure a mortgage without monthly mortgage insurance fees.
If youre having trouble gathering funds for a down payment, you might find yourself considering using your 401 retirement fund as a convenient source of cash. While this is technically allowed, and could help you cover your down payment, there are some factors and drawbacks that you might want to consider.
Well break down the pros and cons of making a 401 withdrawal for a home purchase, as well as some alternatives.
Topic No 557 Additional Tax On Early Distributions From Traditional And Roth Iras
To discourage the use of IRA distributions for purposes other than retirement, you’ll be assessed a 10% additional tax on early distributions from traditional and Roth IRAs, unless an exception applies. Generally, early distributions are those you receive from an IRA before reaching age 59½. The 10% additional tax applies to the part of the distribution that you have to include in gross income. It’s in addition to any regular income tax on that amount.
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How To Qualify For The Rrsp First
You need to meet several requirements to become eligible for the HBP. The first requirement is that you have to be a Canadian citizen. Second, you must sign an agreement stating that the funds you withdraw from your RRSP through the HBP go towards purchasing your first home. The HBP entitles you to a one-time withdrawal from your RRSP for up to $35,000 to put towards the down payment.
The funds you withdraw from your RRSP must have been stored in your account for at least 90 days before withdrawal. You must withdraw the amount from your RRSP within 30 days of taking the title of the home.
Qualifying for the HBP also requires that the buyers have a minimum down payment of 5% of the homes total purchase price, and the household income must be below $120,000.
For Ira Distribution Exception For 1st Time House Purchase What Form Of Proof Must I Furnish To Irs That Distribution Was For House Purchase And When Must I Furnish It
Assuming it would be an early withdrawal, the maximum amount you can pull from your IRA for a first time home purchase is $10,000. For that withdrawal you will receive a 1099-R showing a code 1 in box 7 indicating that it’s an early withdrawal and therefore subject to taxes *and* the 10% early withdrawal penalty.
Then when reporting your home purchase, you show that you spent $10,000 buying that first home and that’s it. All that information will be on the HUD-1 closing statement that you will receive at the closing. Keep that HUD-1 statement *FOREVER*. I can guarantee you that you will need it in the future.
Do understand that you *WILL* pay taxes on the early withdrawal no matter what. However, when you indicate the entire amount was used for a first time home purchase, the 10% penalty will be waived.
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Other Down Payment Funding Options
Taking money from your 401 either in loan or withdrawal form is not the only way to come up with money that you can use for a down payment on a house. Here are some other options that are available:
- FHA Loans
If you’re a first-time homebuyer, you can get an FHA loan to finance your home purchase. With an FHA loan, you will not have to put down 1020%. Instead, you can put a minimum of 3.5% down as long as your credit score is above 580.
- Gift From Friends or Family
If you have a generous friend or family member who is willing to help you out with a down payment, then this is a good option. Most lenders will allow gifts to be used for a down payment. However, the amount of gift money that can be used for the down payment may vary depending on the type of loan and the lender. Be sure to ask your lender what their policies are before you try to use a gift as a down payment.
One party that you are not allowed to get a gift from for a down payment is the seller. As Sullivan at HUD explains, “We have long prohibited that the sources of payment be the seller. It is critically important that there be separation between buyer and seller in the transaction. There was a time, for a while, when the FHA would insure mortgages where the buyer of the home was contributing a down payment that was financed by the seller. We found those loans to be incredibly risky and defaulted at a much greater rate. And so, we prohibited that practice.”
- IRA Withdrawals
- Assistance Programs
- Sell Assets
Advantages Of Rrsp First
- The HBP is effectively an interest-free loan that you can take from yourself.
- The funds can go towards the down payment for your new home and help you get closer to your goal of becoming a homeowner.
- You can reuse the HBP for another purchase under the four-year rule.
- There is no maximum payback limit, so you can repay the entire loan immediately if you prefer.
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Is My Home Buyers Plan Balance Up To Date
If you have previously participated in the HBP, you may be able to do so again if:
- your HBP balance is zero on January 1st of the year during which you plan on withdrawing funds under the HBP
- you meet all the other HBP conditions that apply to your situation
Your HBP balance from your last participation is zero when the total of your yearly designated HBP repayments and any amounts included in your income equals the total eligible withdrawals you made from your RRSP under your participation in the HBP.
Note
The RRSP, PRPP, or SPP contributions you make in the first 60 days of a year, and designate as HBP repayments for the previous year reduce your HBP balance for purposes of determining whether your balance is zero on January 1st of the current year. For more information about designating HBP repayments, see repaying your withdrawals.
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Save For Your Down Payment
Youll need at least 5% of the total home value for a down payment. The bigger the down payment, the less youll need to borrow. Your down payment can come from:
- Personal savings
- Monetary gifts from family or friends
- Money from your Registered Retirement Savings Plan you can withdraw up to $35,000 tax-free under the Home Buyers Plan to use towards the purchase of your home
Havent begun to save yet? Its easy to get started:
- Create a saving plan to achieve your down payment by your target date
- Set up pre-authorized transfers to a savings account dedicated to your down payment
- If you get a gift, a bonus or find you have extra money, allocate part of that to your down payment savings account this can help you buy your house sooner or afford a bigger house
Withdrawing Money From Your Rrsp Under The First
Withdrawing money under the RRSP first-time HBP is more complicated than merely asking your bank to transfer the money for you to use as a down payment for your home. You will need to download and fill out the T1036 Home Buyers Plan request form to Withdraw Funds from an RRSP form on the Canada Revenue Agency website.
You can print out the form or use the fillable or savable option. You will need several T1036 HBP Request forms if you have multiple RRSP accounts.
Suppose you have money in an RRSP investment account and an RRSP savings account, and you need to withdraw money from both to contribute to the down payment. In that case, you will need to fill out and submit two forms. The form is a single page that consists of two sections: Area 1 and Area 2.
You must fill out the details in Area 1 as the homebuyer and submit the form to your bank. The bank will then fill out Area 2 and move the money from your RRSP to your desired account. The process may take a few days to complete.
Once the bank transfers the money into your account, you can use it to make the down payment on your home. Your financial institution will issue you a T4RSP form near tax season or immediately. This form confirms the amount you withdrew from your RRSP under the HBP. It can help ensure that no tax is withheld on your withdrawals when you file your taxes that year.
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Who Is Considered A First
You must be considered a first-time home buyer in Canada to qualify for the HBP withdrawal from your RRSP. However, you dont technically need to be a first-time homebuyer to use the HBP. You can take advantage of the government program more than once by following the four-year rule.
If you wait four years between home purchases and completely pay back the first withdrawal to your RRSP, you can use the RRSP first-time home buyers plan again. In addition, if you are related to a person with a disability, you can gift them the money from your RRSP. The key rule to note here is that whoever benefits from the HBP must live at the property as their primary residence.
First Time Home Buyer Rrsp Withdrawal
This is an obvious point but I want to emphasize it anyway. You need to actually have $35,000 in your RRSP if you want to withdraw $35,000 for a downpayment on a house. To save this amount, youd need to set aside approximately $580 per month for 5 years.
Its easier to save money in your RRSP than you might think. Because this is a tax-advantaged account designed to let you contribute pre-tax income to your retirement savings, doing so can really give you a break when you file your income taxes.
If your income is greater than $50,000, it can make sense to make contributions to your RRSP and claim these contributions when you file your taxes. This will usually result in an income tax refund, which you can further use to top up your RRSP.
The best way to grow your RRSP fast is to invest in the stock market. You can use Questrade, if your comfortable managing your own portfolio, or Wealthsimple if you want a hands-off approach.
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Roth Ira Withdrawal Rules
Most early withdrawals from a tax-advantaged retirement account before age 59 ½ cost you taxes and a 10% penalty, says Jeffrey Levine, certified public accountant and the director of advanced planning with Buckingham Strategic Wealth.
But with a Roth IRA, you may be able to avoid both taxes and penalties if youve had the account open for at least five years and use it to fund a first-time home purchase.
As long as your Roth IRA has been established for at least five years, you can use that money penalty-free for a home down payment as long as it qualifies as a first-time home purchase, Levine says. The nice thing about Roth IRA withdrawal is that the contributions you originally make can be withdrawn for anything, at any time without penalty. Its when you get into the earnings that you run into trouble.
Roth IRA withdrawal rules allow you to take out up to $10,000 earnings tax and penalty free as long as you use them for a first-time home purchase and you first contributed to a Roth account at least five years ago.
If you withdraw more than $10,000 in earnings, you could run into issues, Levine says. He recommends consulting with a knowledgeable tax professional before moving forward, just to be clear on penalties and other consequences.
Youll also want to make sure you use your withdrawn funds quickly. Money must be used within 120 days for the purchase and it must go directly toward the cost of the home, or you may end up owing taxes and penalties, says Roberge.
