I am interested in the idea of using an S&P Index Fund (probably Vanguard's) within a Roth IRA as a savings vehicle for a downpayment on a house.

I have an emergency fund in an FDIC insured savings account and a 401k already, I am just trying to get a little more bang for my buck by using a tax-advantaged account here.

I figure I would be able to save about $6,000 per year, which is the maximum Roth contribution anyway. Since I can withdraw the contributions at any time without penalty, and I can (currently) withdraw the earnings without penalty or tax for this first-time home purchase (providing I meet the 5 year rule, which I probably will), it seems like this is a good idea because I get to avoid taxes on the earnings in this account. If I end up needing the money before 5 years is up then I will either pay income tax on the earnings or just not withdraw them, depending on how the numbers work out.

So is this a good idea? What other things should I consider? I know the prevailing wisdom is to not place any money you might need within 3-5 years in the market, let's say I was willing to take that risk (my down payment fund is currently in the market at this time anyway).


  • If you're considering the SP500 fund, then what taxes are you trying to avoid? If the distribution is not qualified - add 10% penalty. You can only use $10K for home purchase from your IRA. – littleadv Sep 10 '12 at 17:25
  • Is there something special about an SP500 index fund such that I don't have to pay taxes as it grows in value? Or do I have some remedial tax reading to do in general... Thanks! – Jeremy Sep 10 '12 at 17:46
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    I'm not sure I follow the question. You don't need to pay tax as the investment grows in value, you only pay tax when you sell it. In your scenario you can only withdraw $10K qualified distribution (tax free), so at most your tax savings are $2K ($1.5K if current rates remain). That is assuming you actually have such gains, which with the amounts you mention is highly unlikely. – littleadv Sep 10 '12 at 18:01
  • "is to not place any money you might need within 3-5 years in the market" Well, whether money is in a Roth IRA and how you invest are kind of orthogonal questions. Technically you could invest it in a savings account if you wanted. – user102008 Sep 10 '12 at 19:18
  • @littleadv, thanks. So it sounds like there is an advantage (albiet a small one, no more than $1.5-2k in tax savings over 5 years) to this plan? – Jeremy Sep 10 '12 at 19:27

I'll summarize here our discussion in the comments.

First thing to remember is that you can only deposit up to $6K/year into the Roth IRA, you cannot seed it with some large amount (unless its a rollover).

Second thing to remember is that you can only qualify 10K distribution for the home purchase.

With that in mind, it seems that you'll have to have extremly high returns to make use of the maximum tax benefit (15-20% of the 10K). Non-qualified distributions will be taxed at ordinary income rates + 10% penalty, so if you can't qualify the distribution, instead of saving money on taxes, you'll end up paying twice as much as you would have without the IRA.

Also, keep in mind that reporting of the distributions and justifying the qualifications might require assistance of a tax preparer, which will also reduce your savings.

Bottom line, IMHO, you'll end up with a wash or very insignificant savings (compared to the magnitude of the home purchase costs) at best, which renders the whole thing kindof wastefull.

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