Money in your IRA accounts serves a special purpose — to help you build a nest egg for retirement. To that end, the IRS gives IRA account holders outstanding tax advantages, such as tax-deferred investment gains and tax deductions on all or part of your contributions. Given these tax benefits, the IRS also imposes steep penalties to those who tap their IRA before age 59 1/2 — a 10% early withdrawal penalty, plus inclusion of that withdrawal into your taxable income.
However, the IRS does allow exceptions to this early withdrawal rule. One is for first-time home buyers. First-time home buyers can withdraw up to $10,000 from their IRAs without penalty. This applies on a per-person basis, too, so a couple could technically tap into $20,000 of their IRAs penalty free. That’s almost a 5% down payment on a $407,600 home — the median existing-home sale price in April 2024, according to the National Association of Realtors.
Dipping into your IRA early to buy your first home might be tempting, especially if you’ve struggling to put aside funds for a down payment, However, it can come with some long-term consequences, which could seriously set back your retirement plans.
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Consider the opportunity costs before raiding your IRA
When you withdraw from your IRA early, you’re not only taking the money that’s there. You’re also depriving that money of the chance to grow. In fact, depending on how much you withdraw, you could be leaving hundreds of thousands of dollars on the table.
The money in your IRA will be invested in securities, like stocks or funds. Your portfolio’s lifetime returns will depend on the securities you invest in, but it’s not unreasonable to see average returns of 10% if you stay invested in an S&P 500 fund for a long period. In fact, the stock market has averaged about 10% over the past 50 years (before inflation) as measured by the S&P 500. While the stock market’s returns will swing widely each year, sticking with it for a long period will help you balance out the lows with highs.
Let’s say you’re 35, and you and your partner have $20,000 in two separate IRA accounts. If you were to keep this invested in the stock market, an average annual return of 10% would grow your balance to about $350,000 after 30 years. Under similar conditions, you could grow it to about $562,000 after 35 years, $905,000 after 40 years, and $1.4 million after 45 years. That’s a lot of growth for a relatively small initial deposit, not to mention tax free for those who hold it in an IRA.
If you can, avoid early IRA withdrawals
Of course, no retirement advice is one size fits all. If you already understand the consequences of raiding your IRA accounts, but believe by doing so you will help your financial situation, by all means — do what you think is best for your household.
However, if eagerness is taking precedence over wisdom, if you’re not in the best position to buy a house but really want to be, it might be best to leave the IRA off the table. Even if it means delaying homeownership, it could also mean retiring earlier, something you’ll be grateful for many decades down the road.
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