Yahoo Finance Want to set yourself up in a home for retirement? You can use your IRA — but here’s why you shouldn’t
When retirement is on the horizon, it’s natural to start thinking about where you want to spend your later years. In fact, you may even be tempted to buy a house now to set yourself up for the life you want as a retiree.
Of course, this is also a time in life when you may have lots of financial obligations, from sending kids to college to saving for that imminent retirement. If you’re cash-strapped but have built up a pretty good balance in your IRA, it’s natural to wonder if you can use that money to purchase your future retirement home.
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The answer is that you can, and there are a couple of ways to do it — but both have some pretty significant downsides. Here are the options, along with some reasons you probably don’t want to take advantage of either one.
Buying a house within your IRA
When you’re eyeing a house for your future retirement and thinking of using your IRA funds to pay for it, one possibility is to buy the house within an IRA.
You may not know you can do this, but here’s how it works. You don’t have to keep your IRA with a brokerage firm and invest in equities. You can open a self-directed IRA and buy other assets, including real estate.
There are companies that will set up a self-directed IRA and act as the custodian for you, often for a hefty fee. Once you’ve opened and funded your self-directed IRA, you can make a home purchase within it. However, there’s a really big catch — you can’t engage in any self-dealing with your IRA funds. That means you (and your family) can’t personally benefit from the investment property.
You can’t live in the house or let family members live there, even if they pay rent. You can’t use it for personal reasons under any circumstances at all. You can’t even buy furniture for the property from your own funds, it all has to come from the IRA.
If you do decide to live in the house upon retirement you’d have to take the property as a distribution and pay taxes on the distribution. This could leave you with a huge bill, especially if the property has gone up in value. The tax bill could be so big that you can’t afford to cover it without selling or mortgaging the property.
As if that wasn’t enough reason not to do this, the money you’ve used to buy the house won’t be available for your use in retirement, and it won’t be invested in other things that help your account grow. You won’t have all those funds in your retirement account to provide the money you actually need to live on when you're no longer getting paychecks.
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Taking a distribution to buy a house
You also have another option. If you’re a first-time home buyer, you can take up to a $10,000 IRA distribution to use towards a house without paying the early withdrawal penalty that usually applies when taking money out of an IRA before 591/2. A first-time home buyer is someone who has either never owned a property or not owned a primary residence for two years.
However, while you won’t have to pay the customary 10% early withdrawal penalty, you’ll still have to pay ordinary income tax on the distributed funds.
In this situation, you'll also be raiding your retirement account of funds that could otherwise remain invested in equities that grow in value over time. This reduces the balance you end up with and leaves you with less to live on. Yes, you’ll have the house — but the home is an illiquid asset.
Even if the house does go up in value, you can't realize gains or get cash out of it to cover your bills in retirement unless you sell or take out a mortgage or a home equity loan. You wouldn’t want to do that if you were hoping to live in it as a retiree.
The bottom line is, if you’re nearing retirement and can’t afford to put down a down payment and buy a home with an affordable mortgage, you should not move forward with purchasing one.
Taking on this type of commitment so late in life already increases the chances of financial hardship in retirement — but you'll really put yourself in a bad situation if you buy a house you can’t afford and use up the funds in your IRA to do it. That’s the last thing you need to do if you’re in search of a comfortable future.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
