Dear Ray,

I don’t have enough money saved for a down payment on a home. I just learned that I can borrow the down payment from my 401K. What is your opinion? Is this a good strategy?

— John H.

These days, saving for a down payment is tougher than it’s ever been. The good news is, you can use your retirement account (401(k), Roth IRA, IRA) to buy a primary residence and also to purchase investment properties.

Let’s start with the simple IRA account. You can use your Individual Retirement Account (IRA) to buy a home. If allowed by your employer and your IRA plan, you can take advantage of the hardship rule for early withdrawals. If you qualify under this rule, you can withdraw up to $10,000 from your IRA for use toward a down payment, and you don’t need to pay the tax penalty for an early withdrawal from your IRA.

There are some rules you need to know. First, the home must be your primary residence. Second, you can’t have owned a home for the previous two years. Third, you can’t use the IRA funds for the purchase of a vacation home, like a cabin or condo on the beach. Fourth, you can use the IRA funds to buy a home for someone else, such as a spouse, a child or grandchild. Fifth, once you’ve withdrawn $10,000 from your IRA toward a home purchase, you cannot use any other IRA funds for the rest of your life without incurring a tax penalty.

Tax-free, penalty-free?

There are some creative ways you can tap into your IRA that most people don’t consider. Say your daughter needs $20,000 for a down payment on a home. She can take $10,000 from her IRA, and you can take $10,000 from your IRA. You can use both IRA withdrawals for the $20,000 down payment.

You can also use your 401(k) account to purchase a home. You can borrow up to half the balance in your 401(k) account, up to a limit of $50,000, at any age and for any reason without tax or penalty. Loans from a 401(k) account must be repaid within five years, but your employer may give you up to 15 years to repay a 401(k) loan if you are borrowing the money to buy a home. The interest you’ll pay on the loan goes back into your 401(k) account.

There is one major drawback to borrowing from your 401(k) account: If you lose your job, you’ll have just 60 to 90 days to pay back the loan, or you’ll be subject to taxes and a 10-percent early-withdrawal penalty if you’re younger than 55.

Taking money from your Roth IRA is also an option. You can withdraw up to the amount of your IRA contributions tax-free and penalty-free for any reason at any age. (If you withdraw any earnings from a Roth IRA before age 59 1/2, you must pay taxes and a 10-percent penalty.)

If you’re using your earnings to purchase your first home, you and a spouse can each withdraw $10,000 in earnings from your respective Roth IRAs without any early withdrawal penalty. You will avoid a tax bill on the withdrawal if you’ve had the account at least five years; if you haven’t had the account for five years, then you’ll owe taxes on the $10,000, but not the 10-percent penalty.

You may want to consider setting up a “self-directed” retirement account with a company that specializes in real estate IRAs. Once you have a real estate IRA, you can buy and sell all types of real estate, including rental properties, commercial properties, vacation rentals, fixer-uppers and even raw land.

Remember, the self-directed IRA owns the property, not you. If you later sell the property, the profits go into the IRA account — not into your pocket.

Using a self-directed IRA, you can also buy a partial interest in a property. For example, if you don’t have enough money to buy 100 percent of the property, you can partner with another IRA owned by you or one owned by another individual. Or your IRA can partner with you using non-retirement money. 

No limit to earnings

I’ve covered some of the key points of using your retirement account to purchase real estate. Fair warning: There are myriad rules for each strategy. To fully understand your options, you’ll need to meet with an expert.

The good news is, there are several ways you can use your retirement savings to invest in real estate. While your contributions to your retirement savings may be limited, there is no limit on how much your retirement account can earn.

Seattle real estate is forecast to increase 18 percent in value between 2014 and 2018. You don’t need to leave your 401(k) at the mercy of Wall Street’s ups and downs. Why not put those retirement dollars to work in a safer, real estate investment? 

RAY AKERS is a licensed Realtor for Lake & Co. Real Estate in Seattle. Send your questions to ray@akerscargill.com or call (206) 722-4444.