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My wife & I are 28 years old and are looking to purchase our first home in the next 1-3 years. Our financial situation looks something like this:

  • 24% combined gross annual income in low interest student loans (half at 2.62%, half at 3.12%)
  • Our 403-B is currently worth 24% of our FY2010 combined gross annual income
  • We have about 3 months of salary is set aside in a 1% FDIC insured savings account for a rainy day
  • We are growing a small pool of money to ideally put 20% down on a new home in the next 1-3 years

My employer-provided 403-b company offers a Roth IRA with one fund that guarantees a 3% return. Should I start a Roth IRA today (contributing the maximum per year to the guaranteed 3% fund) with intentions of withdrawing the $10,000 ($20,000 joint) maximum of contributions towards the down-payment of our first home?

It's unclear if we would incur a 10% tax on withdrawals, since Roth IRA would certainly be less than 5 years old and we are younger than 59.5 years old... Is there an exception for first time homebuyers for the 5-year/10% penalty?

If we would be charged a 10% early withdraw penalty, what should we do with our downpayment money that we're saving? Should we bother setting extra money aside in an IRA, even if it means it will take longer to purchase our first home?

Update:

BankRate.com is showing 1-year CDs with up to 1.55% APY. That's nearly half of what I could earn with the 3% guaranteed fund! It seems to me deciding between the 3% guaranteed fund and a 1.55% CD depends on tax penalties for early withdrawal. Are Roth IRAs charged a 10% penalty for withdrawing up to $10,000 ($20,000 joint) for first-time home buyers on IRAs less than 5 years old?

  • 1
    Hi Pete, You might split this into two questions. The first (original question) is about where to save for your downpayment. The second question is a great question about roth IRAs and penalties. I'd ask that in a separate thread to give it the attention it deserves so that you get the answers you want. They are related in your situation, but would benefit from being separate on this Q&A site. – Alex B Aug 12 '10 at 1:24
  • Good idea. Migrated here. – Pete Aug 12 '10 at 4:20
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With a Roth IRA, you can withdraw the contributions at any time without penalty as long as you don't withdraw the earnings/interest. There are some circumstances where you can withdraw the earnings such as disability (and maybe first home).

Also, the Roth IRA doesn't need to go through your employer and I wouldn't do it through your employer. I have mine setup through Fidelity though I'm not sure if they have any guaranteed 3% return unless it was a CD. All of mine is in stocks. Your wife could also setup a Roth IRA so over 2 years, you could contribute $20,000.

If I was you, I would just max out any 403-b matches (which you surely are at 25% of gross income) and then save my down payment money in a normal money market/savings account. You are doing good contributing almost 25% to the 403-b.

There are also some income limitations on Roth IRAs. I believe for a married couple, it is $160k.

  • For the record, our 403-b is worth 25% of our combined gross income... I'm not contributing 25% per year! We are well below the income limitation and I don't see how a low-interest money market/savings account is better than a low-risk guaranteed 3% return on the Traditional Annuity I link to above. – Pete Aug 11 '10 at 22:58
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If you are going to be buying a house in 1-2 years, I would be putting my money into a short term holding area like a high interest (which isn't that high right now) or a CD (also low interest) because of your near-term need. I wouldn't use the Roth option for your down payment money.

If you invest in something volatile (and stocks/mutual funds are very volatile in a 1-2 year term) I would consider it too risky for your need and time frame.

  • Yea, we do not want anything at all risky with our timeframe of 1-3 years towards purchasing. – Pete Aug 11 '10 at 23:01
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Lets do the math (assuming a lot of stuff, like your interest rates and that you make the contribution at the beginning of the year, also your tax bracket at the withdrawal time frame.)

1.) Beginning of year 1

Roth Option $5k contribution

Non Roth Option $5k contribution

2.) Beginning of year 2

Roth Option $5000 + $150 interest + 5K contribution = $10150

Non Roth Option $5000 + $75 interest + 5K contribution = $10075

3.) End of year 2

Buy a house! yay!

Roth Option---before withdrawal account value = 10150+10150*.03=10454.5

after withdrawl (assuming 38% tax on earnings withdrawal (10%penalty + 28% income tax estimate.) = 10327.17

Non Roth Option = 10 226.125

So you are talking about a significant amount of paperwork to either 1.) Net yourself $100 toward the purchase 2.) Cost yourself $226 on the purchase but have $454.50 in your roth ira.

I am not sure I would do that, but it might be worth it.

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First, look at the local housing market, and the price to rent ratios. If you are comfortable that a house can be had for near to the cost of renting, and are not still dropping is price, then focus on the down-payment. I don't imagine housing prices to start picking up any time soon, so you don't be too rushed.

If you feel like you have a longer time to save before you want to buy, I would focus as much money as I can into a retirement account while still saving for a down payment.

Since you are young, you really want your retirement accounts working for you as soon as possible. You should not be investing in 3% stable funds, but the stock market index funds. Retirement is for 40 years in the future.

Using funds for a down-payment from a retirement account should be a last resort. Remember this money is to provide you security later in life, not to get you into a house. When you take out money and put it into a house, it will not be appreciating nearly as fast. It is easy to say you will save later, but the money you save early in life will make up 50% or more of your funds when you retire. That is why it is critical to save for retirement as soon as possible.

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