It can be difficult for younger people to save up to purchase their first house. Paying rent, making a car payment and perhaps paying off a student loan can drain your cash flow. While a Roth IRA is designed to be used for retirement one possible use would be to use a Roth IRA for the down payment on your first home.
Roth IRA Basics
Individuals can contribute up to $5,500 into a Roth IRA annually. People over age 50 can make a so-called ‘catch-up’ contribution of an additional $1,000 for a total of $6,500. You will need to have earned income of at least this amount to make the contribution. Earned income is from working as an employee or being self-employed. Unlike the regular IRA there is no income tax deduction for a Roth IRA contribution. A contribution to a Roth IRA is made with after tax dollars. There is an income limitation with the Roth IRA. In 2013 a married couple making less than $178,000 is fully eligible. If there income is over $188,000 they are not eligible. There is a partial eligibility between these two amounts. The benefit to the Roth is that if the account is open for at least 5 years and the taxpayer is over age 59 1/2 then all of the distributions are tax free.
If someone contributed to a Roth IRA for 5 years they would have put in $27,500. If a married couple was able to maximize their contributions they would have put in $27,500 each or a total of $55,000. Any contributions to a Roth IRA can be withdrawn at any time without tax. Certainly housing prices vary based on their geographic location. So depending on where you lived, this may or may not take you very far with your down payment.
Roth IRA or 401(k) Plan
Many employees will have the opportunity to participate in a 401(k) plan at work. With only a certain amount of money to go around they will have to decide if they should use the Roth IRA or contribute to the 401(k) plan. If the employer offers a match in the plan then clearly you want to participate and get this match. However if the plan does not offer a match a Roth IRA would be the preferred vehicle. One of the main benefits of a 401(k) plan is the employer match and the tax deferral. If there is no match and you are younger and just getting started in your career your income tax bracket may not be very high. If you have a lower tax bracket, tax deferral is not as advantageous to you. This would be an ideal time to take advantage of the Roth IRA.
Will you use a Roth IRA to help you purchase your first home?
Many 401k plans now offer a Roth 401k. If this is true for you, it may be the investment vehicle upgrade you need. The Roth 401k will allow you to pay taxes on your retirement savings contributions upfront and avoid future taxes. All withdrawals of Roth savings are free from federal income tax in retirement.
Agreed, the Roth 401(k) is an excellent tool. Not everyone however will work for an employer that offers this option. Therefore for many a Roth IRA is a viable choice.