After years of steadily building an individual retirement account, buying a home may finally be within reach. But for many first-time buyers, a familiar financial hurdle remains: Much of their available cash is tied up in retirement savings.
The IRS offers a notable exception for homebuyers, waiving the 10% early withdrawal penalty on up to $10,000 from an IRA for qualified first-time purchasers.
Thousands of buyers tap that provision each year, treating their retirement savings as a convenient bridge to the closing table.
A recent Charles Schwab analysis walks buyers through the full math behind that decision, including taxes, lost growth, and a permanently smaller retirement balance.
The firm’s projections suggest that a single $10,000 withdrawal can balloon into a six-figure loss over the span of a working career.
The IRS homebuyer exception and its overlooked limits
The first-time homebuyer exception allows up to $10,000 to be withdrawn from an IRA without the standard 10% early withdrawal penalty, Schwab noted.
The $10,000 limit applies over a lifetime, while married couples can each claim the full amount, allowing for a combined withdrawal of up to $20,000.
To qualify, neither you nor your spouse can have owned a principal residence during the two years before the purchase, according to IRS Publication 590-B.
The withdrawn funds must go toward buying, building, or rebuilding a home, and the full amount must be spent within 120 days.
Here is the detail that confuses most buyers considering this move: Penalty-free does not mean tax-free for traditional IRA holders.
Withdrawals from a traditional IRA still count as ordinary income in the year they are taken, even with the homebuyer exemption, the firm explained.
In the 22% federal bracket, for example, a $10,000 withdrawal would generate a $2,200 income tax bill before any state taxes are factored in.
How a $10,000 withdrawal becomes a six-figure loss by retirement
The penalty waiver can save $1,000 on a $10,000 withdrawal, but the potential loss of decades of compound growth could ultimately far exceed that initial savings.
That same $10,000 left untouched in an IRA would grow to about $32,071 over 20 years at an average 6% annual return, the firm reported.
Over a 30-year horizon, the balance would reach $57,434, and over 35 years the projected amount climbs to an estimated $76,860.
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A buyer who withdraws $10,000 at age 30 could forfeit more than $172,000 in compound growth by the time they retire at 67.
That figure assumes an 8% average annual return over 37 years of compounding, Jeff Hunter, wealth strategist at TD Wealth in Chadds Ford, Pa., told Realtor.com.
Nicholas Hamilton, national manager of Alliant retirement and investment services at Alliant Credit Union in Chicago, warned that homeownership can build wealth, but not at the expense of retirement savings.
“The biggest risk isn’t the tax bill; it’s the lost compounding that can’t be recovered,” Hamilton told Realtor.com.
How Roth and traditional IRA rules differ for homebuyers
Traditional IRA contributions are made with pre-tax dollars, so every dollar withdrawn is taxed as ordinary income even when the 10% penalty is waived. That tax bill reduces the cash available at closing and could push you into a higher federal tax bracket for the year.
Roth IRA holders have more flexibility because contributions were already taxed before entering the account and can be withdrawn at any time without penalties.
Up to $10,000 in Roth earnings can be withdrawn penalty-free under the homebuyer exemption, Schwab noted.
If the Roth account is at least five years old, those earnings are also tax-free; if it is younger than five years, the earnings remain subject to ordinary income tax, even though the penalty is waived.
Lower-cost alternatives that preserve retirement savings
First-time homebuyers face considerable headwinds in the current housing market, and the pressure to assemble down-payment cash can feel overwhelming.
Stephen Kates, a financial analyst at personal finance website Bankrate, told the Associated Press that between a 401(k) loan and a hardship withdrawal, borrowing against the plan is the smarter move because the funds eventually return to the retirement account with interest.
…The loan is the more preferable option, because you can borrow from yourself; you’re going to pay yourself back with interest.
Schwab and the advisors quoted in the Realtor.com report cited long-term compounding losses as the reason IRA withdrawals often prove more expensive than lower-down-payment loan products, even after the penalty is waived.
Loans backed by the Federal Housing Administration (FHA) require as little as 3.5% down for borrowers with a credit score of 580 or higher.
“The goal of buying a home should be to improve long-term financial stability, not weaken it,” Brian Zink, CEO of No Upfront Tax Relief in Phoenix, told Realtor.com.
The long-term math behind the retirement-account withdrawal decision
Using a small Roth contribution withdrawal as a bridge can work for buyers who are financially stable and plan to resume saving, Hamilton indicated, as Realtor.com reported.
Relying on retirement funds as a primary down payment source, or assuming home equity replaces decades of compounding, often leads to long-term regret, he warned.
The advisors quoted in the Realtor.com report framed the decision as a trade between $1,000 in penalty savings and tens of thousands in potential future retirement income.
Related: Fidelity breaks down IRA rules that catch heirs off guard
