How to Avoid Roth IRA 5 Year Penalties for a 1st Home Purchase
A Roth IRA is a type of individual retirement account. It allows investors who meet the certain requirements to withdraw money from their account tax-free at retirement age, unlike Traditional IRAs or 401(k)s. You are also allowed to withdraw money from your Roth IRA if you fall under the government's qualification for a "first-time home buyer" without paying any taxes or fees for early withdrawal.
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Instructions
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Open a Roth IRA account through a broker. You'll pick out the funds you wish to invest in, print out the application forms provided by the firm, and fill out the forms and mail a check to the brokerage. The tax law doesn't set a minimum size for a Roth IRA but often you'll need $3,000 to open the account. After this initial step, the broker usually will allow you to set up electronic fund transfers to manage your account and make contributions and withdrawals online.
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You must have the Roth IRA established for at least five years before you can withdraw money without paying any penalties. After that point, the withdrawal will be considered to be a "qualified distribution", and will be free from any penalties or federal tax although you may have to pay state tax depending on where you live.
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Look at the Internal Revenue Service guidelines to see if you qualify as a first-time home buyer. Generally, you're considered a first-time buyer if you haven't owned a principal residence--the house you live in on a daily basis--for a minimum of three years. This doesn't apply to vacation or rental property. You need to spend the money on the house within 120 days of withdrawing it, and you can withdraw up to $10,000. The $10,000 is a lifetime limit, so once you hit that point, you can't do it again.
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The qualified distribution must be spent on the purchase of the house. You can't use it on paying off the mortgage, making repairs or furnishing the house. Those expenses are subject to penalties and fees.
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Tips & Warnings
The $10,000 lifetime limit for qualified distributions is per person, not per couple, so you can work your way around this by drawing part of the money from your Roth and part from your spouse's.
Keep in mind that any money you withdraw from your IRA will NOT be growing to fund your retirement, which could cost you in the long run. Also remember that your yearly contributions are capped by the government--$5,000 for people younger than 50, $6,000 for people 50 and older--so even if you have the money to re-invest into your Roth, you might not be able to.
