The Roth Advantage Part 2: First Time Homebuyer


March 16, 2018

Dan Kresh FPQP™


There are ways for first time homebuyers to access some funds from retirement accounts without "penalty". Though you may be able to avoid an early withdrawal penalty, you will be lowering the amount in your retirement account. You would likely be purchasing your first home many years before you plan to retire, depleting your account when it has the most time to grow. This is a complicated decision. It is important to understand the differences between how you could access funds early from Traditional or Roth IRAs.

A first-time homebuyer can access up to $10,000 from either a Roth or Traditional IRA to contribute towards a down payment[i]. Any funds taken out from a Traditional IRA, for any reason, including a first-time home purchase would be taxed as ordinary income. The tax deferred nature of the Traditional IRA is its biggest advantage, so using funds from a Traditional IRA to help fund a home purchase will forfeit some of that benefit while shrinking your nest egg.
With a Roth IRA, you can take out contributions at any time for any reason without a tax consequence since it's already after-tax dollars[ii]. The Roth IRA owner can also access up to $10,000 of profit for a first-time home purchase, and if you have had the Roth for more than 5 years that would be tax free.[iii] You should NEVER consider a retirement fund an emergency fund, however; the fact remains that there are less barriers and penalties to accessing funds from a Roth IRA early than from a Traditional IRA.

Tapping into your retirement account to buy a home should not be your first choice, but it's nice to know what options could be on the table. You have the best chance of growing your nest egg if you contribute the maximum into your IRA for as long as possible. Taking funds out of your retirement account before retirement age, with or without penalty and or tax, means you will have a smaller principal to hopefully compound over time. Your retirement money will serve you best in retirement and should be invested in a well-diversified portfolio for the long haul. Any investment involves the risk of loss of principal but the more diverse your investments and the longer your time horizon the better your chance is to mitigate that risk.

If your income is at or approaching limits for contributing to a Roth IRA part 3 of this series will discuss a potential way for you to contribute to a Roth IRA using Roth conversions. It's never too early to start thinking about retirement. The earlier you start the more time you have for growth. You work hard for your money, we work hard so your money can work for you.

[i] IRS
[ii]Roth IRA Withdrawl
[iii]IRA To Buy A House

A Roth IRA distribution is qualified if you've had the account for at least five years and/or the distribution is made after you've reached age 59½, because of your total and permanent disability, in the event of your death or for first-time homebuyer expenses. Distributions made prior to age 59 1/2 may be subject to a federal income tax penalty. If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings.

You should always consult a tax professional and though this piece contains some tax information it should not be considered tax advice.

It is far easier to make it than to keep it

I recently read that Evander Holyfield lost his house to a foreclosure auction, when the house sold for $7.5 million - less than half of the outstanding mortgage. Holyfield is also nearly $400,000 delinquent in child support payments – despite earning more than $250 million during his career1.  He’s far from alone in this situation.   According to CNBC, Mike Tyson earned $400 million during his career before he lost it all and declared bankruptcy.  It is not unheard of for a high-profile athlete to lose all of their wealth, but the sheer size of these numbers is staggering. 

There are lessons to be learned.  First, income is not permanent.  Many learned this lesson the hard way in recent years, when established careers and companies evaporated.  But many still live right up to our means or beyond it, thinking that they will continue to earn enough and can save tomorrow.  Our conspicuous consumption society is constantly sending us messages to spend more.  But when approaching retirement, it is more important to spend less.

Our parent’s generation, having lived through the “Great Depression” learned this:  living below your means and saving for tomorrow is the wise course.  It’s good practice for retirement.

All too often, I have heard clients say that they can get by on some small amount during retirement.  I know this is unrealistic, but they don’t, so I give them an exercise to do:  try living on that small amount for three or six months. This is the only way I know that people truly learn this lesson, and it saves them a lot of pain in the future. Almost no one managed it yet.  

The other lesson concerns the value of money.  Since most of us do not have large lump sums of money lying around, we tend to be anchored in our belief that our lump sum of retirement money is a lot of money.  A retirement rollover in the high six figures seems like a great deal of money (“I am a millionaire?”) but when it has to be converted to an income for two or three decades, it is far less than it seems.
 

The inverse is also true.  When is the last time you saw a car ad for the total price of the car?  Maybe $ 50,000 for a car is far too expensive, but gosh, I can afford $350 a month for a new BMW.  Look at the ads carefully – professionals skilled in the science of human behavior use only the monthly price in large typeface, helping you overlook the real cost of the car.  This is especially true in leasing, which creates the perceived affordability of an expensive car.   We are constantly sent messages to spend more, while the true costs are buried in the fine print.

While few of us will have the opportunity to burn through hundreds of millions of dollars, a lifestyle of uncontrolled spending can lead anyone to a similar fate, albeit on a smaller scale, as did Evander Holyfield. Value the income that you earn, consider it a resource that deserves stewardship, and consider the future costs of items that you purchase.  While it’s true that man does not live by bread alone, a diet of filet mignon and lobster makes it difficult to save for twenty years of hamburgers and tuna salad.

It often is very hard to implement changes before we have to (look at Congress), however that is the path that we have to take to prepare for tomorrow. Twenty years ago, during a seminar that I was giving on retirement, I recommended that everybody in the room reduce their spending by 15% to better secure their future retirement.  A gentleman in the back of the room stood up and said “I am 55 years old, and I do not want to sacrifice now.”  I then asked (not so politely)  “When do you want to sacrifice, when you are 70?” 

Today we all have choices, tomorrow we may not.   Make smart choices today so that you do not find yourself in a situation where someone else will be making choices for you, and you can no longer control your own destiny.

Michael Kresh CFP
Managing Member
Creative Wealth Management LLC
 

1
http://www.fa-mag.com/fa-news/11796-holyfield
 
 


DISCLAIMER:

*The views expressed are not necessarily the opinion of Royal Alliance Associates, Inc., and should not be construed directly or indirectly, as an offer to buy or sell any securities mentioned herein. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Individual circumstances vary. Investing is subject to risks including loss of principal invested. No strategy including asset allocation or diversification can assure a profit against loss.

Fixed income investments are subject to various risks including changes in interest rates, credit quality, and other factors. Securities sold or redeemed prior to maturity may be subject to a substantial gain or loss. In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities.

Investors should understand that investing in strategies that are non-correlated to the stock and bond markets are not without risk. There can be no assurance that alternative investments will be profitable and will even outperform asset classes correlated to the stock and bond markets.

 

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