Knowing how sacrosanct retirement accounts are viewed by many I wonder if people have considered using a Roth IRA as a saving alternative. Before attacking my idea stop and think; there are many investments that will help you save for retirement and in some cases it may make sense to shift the money from one retirement account to another. In many cases this isn’t possible, but here is one scenario where it is possible.
Roth IRA’s have many benefits, the most frequently noted being no taxes on earnings and no taxes on withdrawals of those earnings after 59 1/2 years of age. They also benefit from allowing a wide range of investments including stocks, ETF’s, bonds, derivatives and real estate. And let’s not forget that there are no are related withdrawal limits set on IRA’s. It is one of the few retirement accounts that can continue growing for your entire life and then be passed on to your heirs tax free!
Today though I want to focus on two other benefits of the Roth IRA, namely the ability to withdraw and contributions tax and penalty free and the ability to use up to $10,000 worth of the earnings tax and penalty free for a qualified home purchase.
While it isn’t normally recommended that you withdraw retirement savings, I think in this case it could be a winning use of your Roth IRA funds. Of course this is dependent on your having other retirement savings such as a company pension, 401(k) or 403(b). If this is the case I don’t feel that a hit to your Roth would be devastating, especially when used to purchase another asset that could be considered as a retirement investment. And don’t forget that both spouses can contribute up to $5000 per year into a Roth, meaning you double your savings. If you are thinking long term (4-5 years) and saving for the down payment on a house then the Roth IRA might be a good vehicle for you to use.
Let’s take a look at the fictional couple Brian and Courtney. They are newly married and would like to save for a house so they can start a family, but the down payment requirements are so high they don’t know when they will be able to switch from renting to buying. Both of them are recent college graduates, have entered the workplace and are contributing to both their company 401(k) and their new Roth IRA’s. Do you think that Brian and Courtney might be good candidates to use their Roth as a savings vehicle towards home ownership?
If they are maxing out their 401(k) contributions then I don’t see anything wrong with earmarking the Roth IRA’s as savings for their down payment on a new home. Here’s why.
Currently both of them are able to sock $18,000 per year into their 401(k) as well as $5000 per year into their Roth. If they both make the maximum contribution each 401(k) would grow to $10,175,944.56 by the time they are 62. This is assuming an 8% annual return (which is lower than the historical return for stocks) and also doesn’t take into account any future increases in the contribution limits. So, if they both continue working and contributing fully they would have a combined $20,351,889.12 when they are ready to retire at 62 years old.
I know, I can hear you already. What if they decide to have kids and Courtney leaves the workforce? Well, in that case they would still have the $10,175,944.56 generated by Brian’s 401(k). In addition, we can safely assume that they won’t have kids until they are able to move into a house (our savers are very responsible and like to plan). So that means a minimum of 5 years contributions to Courtney’s 401(k) as well. This would grow to $1,807,659.26 over the course of 40 years. Certainly not $10 million, but still nothing to sneeze at.
So, we can see that Brian and Courtney do not need their Roth to have enough retirement dollars put aside. And chances are that once they take the withdrawal to buy their home they will continue contributing so the Roth would still have 35 years to grow (assuming they do not go over the income cap).
Now let’s look at how that Roth IRA can help to make them homeowners.
Each of them are able to contribute $5000 per year to their Roth. In 5 years time at a conservative 4% interest rate they would each have $27,716.20 or a total of $55,432.40 that could be withdrawn penalty free for use as a down payment on a house. In addition, all the money would be tax free since it comes from their initial deposits and qualified earnings. That is enough for a 20% down payment on a $200,000 home plus enough to cover the closing costs. And they would have accumulated $221,900.10 already in the two 401(k)’s. Not a bad start for a pair of very young 27 year olds.
Think it isn’t possible to save that aggressively? If each of them makes just the median US income they would have a combined yearly income (after deductions for the 401(k) contributions) of approximately $64,000. I’m pretty sure two recent college grads can live fairly comfortably on $64k per year.
No it isn’t conventional and I’m sure many of you will speak out against a plan like this, but in the scenario I’ve outlined I think it makes perfect sense. The two fictional people I’ve described are young, have plenty of time to save for retirement and are fiscally responsible. And if you accept that the home they will be buying is an asset that can be used in retirement then all they are doing is transferring wealth from one retirement account to another. So, does this make sense or am I out of my mind?