With the housing market in a bit of a slump and interest rates low, I thought it would be a good time to buy my first home. I am planning on buying a condo in the next few months.

My question is this — I know the IRS allows you to take out up to $10,000 from an IRA or a Roth IRA to finance a first-time home purchase. Do you have any thoughts on whether it would be better to take the money out of my Roth versus my Traditional IRA?

-s

Hmm, I would say it’s best to do neither. The IRS allows individuals to withdraw funds from the IRA penalty free, and in the case of the Roth IRA tax free (assuming the withdrawal is after 5 years). The withdrawal is considered a qualified distribution - not much different from taking distributions at retirement. Of course if you’re gains in the traditional non-deductible IRA are limited or non-existent, paying taxes may not come into play at all. Sound great, right? The fundamental problem with taking a distribution early even if it’s penalty and tax free is that you can’t put the money back in.

IRAs, and 401k are tax shelters.  By holding money in these vehicles, investors avoid the annual drag of taxes or in the case of the Roth IRA taxes on gains period.  Every year we only get a certain amount dollars we can shelter, and it’s use it or lose it proposition.  It’s not like we can not contribute one year, and contribute twice as much the next year.  For this reason, I think it’s critical especially when you’re young to get those dollars in, and maximize the amount of money you’re sheltering from taxes for the longest time possible.

I would say if you can look to other sources of funding. I would even suggest borrowing from your 401K.  At least in the case of your 401k, you’re actually putting the money back in.  As long as you’re comfortable with job security and or your ability to pay back the loan if you were to switch or lose your job, I think borrowing from the 401k can a good option especially if the payback period is over a short period.  Yes, you lose some period of tax sheltering, but if the loan period is short it shouldn’t be a big deal.  The criticism of paying taxes twice because you’re paying with after tax dollars is generally overstated since the initial loan is tax free and it’s the only the interest (that you pay to yourself) that is actually taxed twice.