First time Home Buyer and Roth IRA

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Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

First time Home Buyer and Roth IRA

Post by pmdonca »

Hi Bogleheads,

I have a question after reading the article by Kitces.

https://www.kitces.com/blog/understandi ... nversions/

Since, my wife and I have been doing a combination of Back door roth IRA and Mega back door roth IRA yearly for past 3 years. I have invested directly into roth IRA over 5 years ago (actually 6 years ago). Is there another 5 year rule for when I started doing the back door and mega back door roth?

Do we satisfy the 5 year rule including on the money into roth IRA via backdoor and mega backdoor methods? I would like to take huge chunk of money from our roth IRA's as a first time home buyer, in which some of the money in roth IRA has been directly contributed, from back door, and mega backdoor. It will be less than the $10,000 earnings limit. Thank you for your insights and help.
ddurrett896
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Re: First time Home Buyer and Roth IRA

Post by ddurrett896 »

You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
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geerhardusvos
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Re: First time Home Buyer and Roth IRA

Post by geerhardusvos »

pmdonca wrote: Tue Sep 15, 2020 8:02 am I would like to take huge chunk of money from our roth IRA's as a first time home buyer
Do not take money out of your Roth IRA or other retirement accounts to buy a house.
VTSAX and chill
annu
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Re: First time Home Buyer and Roth IRA

Post by annu »

Mortgage rates are super low, why are you looking into cashing out your retirement?
Topic Author
pmdonca
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Re: First time Home Buyer and Roth IRA

Post by pmdonca »

ddurrett896 wrote: Tue Sep 15, 2020 8:05 am You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
My wife and I have invested directly into our Roth IRA’s for the first time about 6 years ago before we were over the income limits where we were forced to do back door roth starting about 4 years ago. So does this mean we met the 5 year rule?
Last edited by pmdonca on Tue Sep 15, 2020 9:16 pm, edited 1 time in total.
Topic Author
pmdonca
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Re: First time Home Buyer and Roth IRA

Post by pmdonca »

annu wrote: Tue Sep 15, 2020 7:05 pm Mortgage rates are super low, why are you looking into cashing out your retirement?
Issue is that the county I am in Northern California Bay Area has loan limits of $510,400 without doing jumbo loan. I am not looking to do jumbo loan with higher rates or PMI. A decent house in the area where we want to be is about $800k. Therefore we would need approximately $290k in loan plus about $20k closing costs, which totals about $310k needed in order to borrow up to the county’s maximum loan limits. We currently have about $210k saved outside of retirement. However, we have a little over $100k in our Roth IRAs (some of it from direct contribution, some from back door and Meg backdoor methods), which would bring us to our goal of being in the $800k house in the area we want to be. We have about an additional $200k in our 401k’s, so it would not completely drain our retirement... As a side note, our current income is about $250k per year before taxes. It would probably take us 1-2 years to save up the additional $100k we would need, but we don’t want to wait that long to save up outside of retirement. With the $510,400 mortgage at low interest and no PMI, we plan to fill our retirements back up quickly. Please advise. Can we take all the money out of our Roth IRA’s since the total earnings is less than $10k total even though the money is a combination of direct contributions, backdoor, mega backdoor and some earnings (less than $10k)? It appears that the $10k is the limit to take out earnings out of Roth IRA tax and penalty free before age 59.5 if using it to purchase house as a first time home buyer.
carloslando
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Joined: Sun Aug 23, 2020 3:28 am

Re: First time Home Buyer and Roth IRA

Post by carloslando »

ddurrett896 wrote: Tue Sep 15, 2020 8:05 am You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
Op seems to have 2 separate contributions:

doing a combination of Back door roth IRA and Mega back door roth IRA yearly for past 3 years.

--> this is not eligible for 5 year rule.


I have invested directly into roth IRA over 5 years ago (actually 6 years ago)


--> If this was either a direct contribution (assuming OP was under Income limits and made direct contributions), or a conversion, either way this would be eligible for 5 year rule, no?
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

carloslando wrote: Tue Sep 15, 2020 9:18 pm
ddurrett896 wrote: Tue Sep 15, 2020 8:05 am You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
Op seems to have 2 separate contributions:

doing a combination of Back door roth IRA and Mega back door roth IRA yearly for past 3 years.

--> this is not eligible for 5 year rule.


I have invested directly into roth IRA over 5 years ago (actually 6 years ago)


--> If this was either a direct contribution (assuming OP was under Income limits and made direct contributions), or a conversion, either way this would be eligible for 5 year rule, no?
So since only the direct contributions satisfied the 5 year rule, does this mean we can only take out the amount that was directly contributed? I would like to take out the rollovers from the backdoor Roth and mega backdoor Roth... So basically the mega backdoor and backdoor Roth has its own 5 year rule? I was hoping that since I directly contributed over 5 years ago and that the the mega backdoor and backdoor Roths from the past 3 years would also satisfy the 5 year rule. Please help me understand the 5 year rule for the Roth money via backdoor and mega backdoor even though we directly contributed 6 years ago...
carloslando
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Joined: Sun Aug 23, 2020 3:28 am

Re: First time Home Buyer and Roth IRA

Post by carloslando »

pmdonca wrote: Tue Sep 15, 2020 11:26 pm
carloslando wrote: Tue Sep 15, 2020 9:18 pm
ddurrett896 wrote: Tue Sep 15, 2020 8:05 am You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
Op seems to have 2 separate contributions:

doing a combination of Back door roth IRA and Mega back door roth IRA yearly for past 3 years.

--> this is not eligible for 5 year rule.


I have invested directly into roth IRA over 5 years ago (actually 6 years ago)


--> If this was either a direct contribution (assuming OP was under Income limits and made direct contributions), or a conversion, either way this would be eligible for 5 year rule, no?
So since only the direct contributions satisfied the 5 year rule, does this mean we can only take out the amount that was directly contributed? I would like to take out the rollovers from the backdoor Roth and mega backdoor Roth... So basically the mega backdoor and backdoor Roth has its own 5 year rule? I was hoping that since I directly contributed over 5 years ago and that the the mega backdoor and backdoor Roths from the past 3 years would also satisfy the 5 year rule. Please help me understand the 5 year rule for the Roth money via backdoor and mega backdoor even though we directly contributed 6 years ago...
- Your Contributions are always available to withdraw, the rules around penalties apply to the Earnings portion of your balance.
- Each conversion of the backdoor IRA->ROTH has its own 5 year clock (see a link to the exact Treasury Regulatory in the BigLawInvestor article below for details)
- As a first-time home buyer you also have a $10,000 exemption to withdraw earnings, provided the account is 5 years old. (so in your case for the 5+ year old account you can withdraw contributions plus up to $10,000 of earnings without a penalty)
- if you have been affected by COVID-19, in 2020 you can withdraw up to $100K from your Roth (& regular) IRA.

https://www.biglawinvestor.com/5-year-roth-ira-rules/
https://www.investopedia.com/articles/p ... y-fund.asp
https://www.schwab.com/ira/roth-ira/withdrawal-rules

Lastly, with Mortgage rates so low now, you should seriously reconsider tapping into the Roth. When trying to add back into Roth you face annual limits even if you have funds to spare (while the mortgage can be paid off earlier if you get some windfalls along the way). From past experience market returns over a long term should beat current mortgage rates, and this is growing tax-free so effective Roth earnings are even more.
surfstar
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Location: Santa Barbara, CA

Re: First time Home Buyer and Roth IRA

Post by surfstar »

Without going into the mechanics of your specific Roth IRA question, I am here to offer support for "raiding" some of your retirement accounts.
We had to tap into a portion of our Roth contributions and also take a TSP loan to get 20% down and avoid PMI. It is worth it to avoid PMI, especially if you are a disciplined investor. We had been fully maxing our tax advantage accounts and had not planned on a home purchase, so didn't have much "cash" for the down payment.
Had some leftover cash after the purchase so we put back some in the Roths (within 60 days) and DW is nearly done with her TSP loan - basically paying it off in 4 year's time, while we've continued to max all tax advantaged space.

We will have more than enough to retire at ages 50/52, despite the "raiding" of accounts, that some decry. It is CA. Sometimes it is needed, and if you are still a Boglehead, you will be just fine. I ran the rent vs buy numbers for so many scenarios before we made the decision. We didn't overbuy. We don't plan on moving. We've refi'd twice already for lower rates, and we couldn't rent something for the equivalent monthly costs.

The blanket rules of BH, don't always apply. Do what you need to avoid PMI, but I wouldn't go further. Your mortgage interest will be at least partially deductible, so don't take out excess Roth funds to try and avoid the Jumbo rates. Shop around for better rates, or refi ASAP and/or when you get down to $510k in the future.
Alan S.
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Location: Prescott, AZ

Re: First time Home Buyer and Roth IRA

Post by Alan S. »

Assuming you determined that tapping your Roth IRAs was beneficial for this purpose, in order to determine how much you would withdraw and the tax implications, you would need to know the exact basis details of each of your Roths separately.

If you can avoid tapping earnings from one or both of your Roths, reporting would be considerably simpler. That said, if the home meets the first home definition and you each first contributed to a Roth IRA prior to 2016, you do qualify for the 10k (lifetime limit) distribution of earnings tax and penalty free.

Without claiming the qualified first home distribution, your distributions would follow the Roth ordering rules. All regular Roth contributions come out first tax and penalty free. All your basic back door and mega back door conversion are under 5 years, so these conversions come out next, oldest first, and within each year, the taxable amount first. The taxable amounts are normally very small with back door conversions, but they would be subject to the 10% penalty except that the first home exception waives the penalty up to 10,000 lifetime for each spouse. Accordingly, except for earnings it appears you could tap the entire regular and conversion basis of your Roths and owe no tax or penalty. You would do that and leave the earnings untouched, which are probably a small portion of your total Roth values anyway.

Finally, do not tap your earnings if you think that drawing the 10k tax free is a permanent benefit. It is not, because as long as you have a Roth balance remaining, your future Roth basis is reduced by 10k as a result of tapping those earnings. This is evident from the Form 8606 reporting instructions, but Pub 590 B does not explain that this is the result.
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

carloslando wrote: Wed Sep 16, 2020 10:55 am
pmdonca wrote: Tue Sep 15, 2020 11:26 pm
carloslando wrote: Tue Sep 15, 2020 9:18 pm
ddurrett896 wrote: Tue Sep 15, 2020 8:05 am You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
Op seems to have 2 separate contributions:

doing a combination of Back door roth IRA and Mega back door roth IRA yearly for past 3 years.

--> this is not eligible for 5 year rule.


I have invested directly into roth IRA over 5 years ago (actually 6 years ago)


--> If this was either a direct contribution (assuming OP was under Income limits and made direct contributions), or a conversion, either way this would be eligible for 5 year rule, no?
So since only the direct contributions satisfied the 5 year rule, does this mean we can only take out the amount that was directly contributed? I would like to take out the rollovers from the backdoor Roth and mega backdoor Roth... So basically the mega backdoor and backdoor Roth has its own 5 year rule? I was hoping that since I directly contributed over 5 years ago and that the the mega backdoor and backdoor Roths from the past 3 years would also satisfy the 5 year rule. Please help me understand the 5 year rule for the Roth money via backdoor and mega backdoor even though we directly contributed 6 years ago...
- Your Contributions are always available to withdraw, the rules around penalties apply to the Earnings portion of your balance.
- Each conversion of the backdoor IRA->ROTH has its own 5 year clock (see a link to the exact Treasury Regulatory in the BigLawInvestor article below for details)
- As a first-time home buyer you also have a $10,000 exemption to withdraw earnings, provided the account is 5 years old. (so in your case for the 5+ year old account you can withdraw contributions plus up to $10,000 of earnings without a penalty)
- if you have been affected by COVID-19, in 2020 you can withdraw up to $100K from your Roth (& regular) IRA.

https://www.biglawinvestor.com/5-year-roth-ira-rules/
https://www.investopedia.com/articles/p ... y-fund.asp
https://www.schwab.com/ira/roth-ira/withdrawal-rules

Lastly, with Mortgage rates so low now, you should seriously reconsider tapping into the Roth. When trying to add back into Roth you face annual limits even if you have funds to spare (while the mortgage can be paid off earlier if you get some windfalls along the way). From past experience market returns over a long term should beat current mortgage rates, and this is growing tax-free so effective Roth earnings are even more.
Given that majority of the money is from backdoor and mega backdoor roth conversions/rollover not the direct contributions even though the direct contributions were from 6 years ago. From what you are saying regarding each rollover have its own 5 year rule, it sounds like I will not be able to withdraw a lot out (without penalty) given that majority is from backdoor and mega backdoor conversions/rollover and all of these were done less than 5 years...
Alan S.
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Location: Prescott, AZ

Re: First time Home Buyer and Roth IRA

Post by Alan S. »

You are missing that the penalty would only apply to the taxable portion of each conversion or qualified rollover. A back door or mega back door Roth rollover is mostly all non taxable, funded predominantly by after tax contributions.

For example, for any year in the past 5 years in which you did a mega back door, if you contributed 10k to your after tax 401k account, and it gained $100 before it was converted, you can withdraw the entire 10,100 from your Roth IRA and the penalty is only $10 (10% of 100). If you add up all these Roth rollovers in the last 5 years, you probably only have no more than $500 of taxable rollovers. So you can tap them all with a combined penalty of $50 (10% of 500), and that penalty is waived by using only 500 of the 10,000 of lifetime penalty waivers for a first time homebuyer.

Therefore tapping all of your basic and mega back door Roth conversions/rollovers should result in no tax or penalty.

However, if you did a fully taxable IRA conversion during that period, it would probably exhaust your 10,000 lifetime limit.
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

Alan S. wrote: Thu Sep 17, 2020 6:12 pm You are missing that the penalty would only apply to the taxable portion of each conversion or qualified rollover. A back door or mega back door Roth rollover is mostly all non taxable, funded predominantly by after tax contributions.

For example, for any year in the past 5 years in which you did a mega back door, if you contributed 10k to your after tax 401k account, and it gained $100 before it was converted, you can withdraw the entire 10,100 from your Roth IRA and the penalty is only $10 (10% of 100). If you add up all these Roth rollovers in the last 5 years, you probably only have no more than $500 of taxable rollovers. So you can tap them all with a combined penalty of $50 (10% of 500), and that penalty is waived by using only 500 of the 10,000 of lifetime penalty waivers for a first time homebuyer.

Therefore tapping all of your basic and mega back door Roth conversions/rollovers should result in no tax or penalty.

However, if you did a fully taxable IRA conversion during that period, it would probably exhaust your 10,000 lifetime limit.
I didn’t realize that the 10% penalty is only on the earnings portion. Is based on the earnings before the rollover and or the earnings in the Roth IRA post backdoor/mega backdoor rollovers?
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

So based on this hypothetical scenario, what would the penalty apply to:

Year of 2018: Let’s say the backdoor Roth $5,500 was performed in May 2018. Let’s say the nondeductible contribution was done on May 10th and I earned $1 by the time I completed the rollover to Roth IRA, so therefore there was $5,501 rolled over. Form 8606 was filed and the $1 in taxable earnings was paid for the 2018 taxes. For this specific back door rollover, it has grown to $6,500 today in the year of 2020. If I were to take out the entire $6,500 from this backdoor Roth rollover/conversion in 2020 when it’s worth $6,500 (less than 5 years) to contribute to purchase first time house, what would my 10% penalty be? What would the taxes be?

For the year of 2018, let’s say I did a similar process for mega back door roth, would the penalty be similar to the regular backdoor Roth conversion/rollover as above example?
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

carloslando wrote: Wed Sep 16, 2020 10:55 am
pmdonca wrote: Tue Sep 15, 2020 11:26 pm
carloslando wrote: Tue Sep 15, 2020 9:18 pm
ddurrett896 wrote: Tue Sep 15, 2020 8:05 am You never contributed to a Roth IRA, you converted to a Roth IRA, making the funds not eligible for the 5 year rule.
Op seems to have 2 separate contributions:

doing a combination of Back door roth IRA and Mega back door roth IRA yearly for past 3 years.

--> this is not eligible for 5 year rule.


I have invested directly into roth IRA over 5 years ago (actually 6 years ago)


--> If this was either a direct contribution (assuming OP was under Income limits and made direct contributions), or a conversion, either way this would be eligible for 5 year rule, no?
So since only the direct contributions satisfied the 5 year rule, does this mean we can only take out the amount that was directly contributed? I would like to take out the rollovers from the backdoor Roth and mega backdoor Roth... So basically the mega backdoor and backdoor Roth has its own 5 year rule? I was hoping that since I directly contributed over 5 years ago and that the the mega backdoor and backdoor Roths from the past 3 years would also satisfy the 5 year rule. Please help me understand the 5 year rule for the Roth money via backdoor and mega backdoor even though we directly contributed 6 years ago...
- Your Contributions are always available to withdraw, the rules around penalties apply to the Earnings portion of your balance.
- Each conversion of the backdoor IRA->ROTH has its own 5 year clock (see a link to the exact Treasury Regulatory in the BigLawInvestor article below for details)
- As a first-time home buyer you also have a $10,000 exemption to withdraw earnings, provided the account is 5 years old. (so in your case for the 5+ year old account you can withdraw contributions plus up to $10,000 of earnings without a penalty)
- if you have been affected by COVID-19, in 2020 you can withdraw up to $100K from your Roth (& regular) IRA.

https://www.biglawinvestor.com/5-year-roth-ira-rules/
https://www.investopedia.com/articles/p ... y-fund.asp
https://www.schwab.com/ira/roth-ira/withdrawal-rules

Lastly, with Mortgage rates so low now, you should seriously reconsider tapping into the Roth. When trying to add back into Roth you face annual limits even if you have funds to spare (while the mortgage can be paid off earlier if you get some windfalls along the way). From past experience market returns over a long term should beat current mortgage rates, and this is growing tax-free so effective Roth earnings are even more.
Based on the rules for the $100k penalty free retirement cash out, we do not meet the requirement of being affected by COVID...
feehater
Posts: 209
Joined: Fri Jul 14, 2017 10:14 am

Re: First time Home Buyer and Roth IRA

Post by feehater »

So just to be clear, you already have 20% down without touching the Roths? Not paying PMI either way right? So this entire scheme is to avoid a slightly/somewhat higher rate on a Jumbo loan? That sounds like a whole lot of extra work to me. I would take the jumbo loan, pay extra over the next year or two, and then refinance once you hit $510k. How would you feel if you lost all this Roth space and then Refi'd anyway?

PS...my lender was very keen on enforcing a rule at the last minute that we had to show we had 6 months of PITI expenses in a bank or taxable account after subtracting the downpayment and closing costs. On a $600k mortgage, that could be another $25k you might need to worry about if you're cutting it close.
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

Alan S. wrote: Thu Sep 17, 2020 6:12 pm You are missing that the penalty would only apply to the taxable portion of each conversion or qualified rollover. A back door or mega back door Roth rollover is mostly all non taxable, funded predominantly by after tax contributions.

For example, for any year in the past 5 years in which you did a mega back door, if you contributed 10k to your after tax 401k account, and it gained $100 before it was converted, you can withdraw the entire 10,100 from your Roth IRA and the penalty is only $10 (10% of 100). If you add up all these Roth rollovers in the last 5 years, you probably only have no more than $500 of taxable rollovers. So you can tap them all with a combined penalty of $50 (10% of 500), and that penalty is waived by using only 500 of the 10,000 of lifetime penalty waivers for a first time homebuyer.

Therefore tapping all of your basic and mega back door Roth conversions/rollovers should result in no tax or penalty.

However, if you did a fully taxable IRA conversion during that period, it would probably exhaust your 10,000 lifetime limit.
That is great news that only the pre conversion earnings is penalized. How about the earnings post-conversion? Fortunately, we never did fully taxable IRA conversion, so this is not an issue with our situation.
Last edited by pmdonca on Sat Sep 19, 2020 3:49 pm, edited 1 time in total.
Topic Author
pmdonca
Posts: 72
Joined: Wed Oct 18, 2017 12:19 pm

Re: First time Home Buyer and Roth IRA

Post by pmdonca »

feehater wrote: Fri Sep 18, 2020 2:31 pm So just to be clear, you already have 20% down without touching the Roths? Not paying PMI either way right? So this entire scheme is to avoid a slightly/somewhat higher rate on a Jumbo loan? That sounds like a whole lot of extra work to me. I would take the jumbo loan, pay extra over the next year or two, and then refinance once you hit $510k. How would you feel if you lost all this Roth space and then Refi'd anyway?

PS...my lender was very keen on enforcing a rule at the last minute that we had to show we had 6 months of PITI expenses in a bank or taxable account after subtracting the downpayment and closing costs. On a $600k mortgage, that could be another $25k you might need to worry about if you're cutting it close.
If I were to take money out of Roth accounts, why would I need to refi if I got the loan at the low rate since I am below the county maximum loan limits? Maybe I am not quite understanding... I didn’t realize of the 6 month requirement for loan. Good to know.
feehater
Posts: 209
Joined: Fri Jul 14, 2017 10:14 am

Re: First time Home Buyer and Roth IRA

Post by feehater »

I was about to start marshaling evidence about how the spread is only about 1/8-1/4 of a point (a year or two ago it was actually 0 or even a bonus to do jumbo), so it should be just be looked at as a math problem. And about how the cost to buy the rate down that much is maybe $5k which seems like a small price to keep that much money in the Roth. But then I realized that if you have, and will continue to have, access to do a mega backdoor, then Roth space to you is much less precious than it is to most people. You can refill that amount in Roths in a few years, as opposed to 10+ years like us mere mortals? If so, then I have much less objection to this scheme. I would still argue, however, that choices you make regarding lenders and Realtors, and their fees, can easily swamp this difference if you are not careful and lucky.
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