What Can Traditional and Roth IRA Money Be Used For?

Socking away thousands of dollars each year into a retirement account is a smart move, but it can be a little unnerving: What if you end up needing that money for something else before you reach retirement age? 

An individual retirement account (IRA), clearly, is intended as a vehicle for saving for retirement; but there are opportunities to use it for other purposes such as buying a first home or paying for college.

Won’t I have to pay penalties for early withdrawals?

It depends. There are penalties associated with some IRA withdrawals made before you reach retirement age. For instance, if you have a traditional IRA, you will owe income tax on the amount you contributed over the years, as well as a penalty of 10 percent if you make withdrawals before you reach age 59 ½. It’s best to avoid early withdrawals from a traditional IRA, but there are some exceptions, discussed below. 

However, if you have a Roth IRA, your contributions were made after paying taxes on the income. So you can withdraw the amount you contributed without incurring any taxes or penalties at any time. If you withdraw any of the earnings on your investment, you may have to pay a penalty of 10 percent plus taxes—but there are exceptions.

What are the exceptions?

If you qualify, there are some exceptions to the rules, allowing you to use IRA funds for purposes other than retirement. 

Buying or building a first home 

An IRA isn’t the most ideal account to save for a down payment on a home, but it is an option. If you’re a first-time homebuyer, or if you and your spouse have not owned a home in the past two years, you can withdraw up to $10,000 from your IRA without penalties to put toward the purchase of a home. 

If you’re using a traditional IRA, you will still have to pay income taxes at your regular tax rate on the $10,000. But you won’t have to pay a penalty.

With a Roth IRA, you could potentially withdraw more than $10,000, if you’ve contributed more than $10,000 to the account. If you’re only taking out your contributions, there’s no limit—but if you take out some of the earnings, you’re subject to the $10,000 limit. And you’ll want to be sure it’s been five years since you started contributing to the account to avoid a penalty. Either way, you won’t have to pay taxes on this withdrawal from a Roth IRA.

Paying for college expenses

You can save for college using an IRA, because the IRS allows you to use IRA funds to pay for qualifying higher education expenses for yourself, your spouse or your dependents without incurring the 10 percent penalty. 

Qualifying education expenses include tuition as well as administrative fees charged by the institution, the cost of books, supplies and equipment. And if the student attends more than half-time, you can also include the cost of room and board. 

To use IRA funds and avoid the penalty, you or your dependent must have education expenses during the year you take the distribution from your IRA. You cannot take the funds out of your IRA to pay off student loans after your student has graduated, for example. Also, the student must attend an eligible institution of higher learning, which can be any college, university, vocational school or other school that is eligible for student aid programs offered by the U.S. Department of Education. 

Even if you qualify to avoid the penalty, you will likely owe income tax on the funds you take out of your IRA to pay for education expenses. If you have a traditional IRA, you’ll be responsible for paying income tax on any amount you withdraw, and with a Roth IRA, you’ll have to pay income tax on any amount you withdraw beyond your contributions.

Paying for medical expenses

If you want to save for potential future medical expenses, you can also use an IRA for that purpose. The IRS allows penalty-free withdrawals from IRAs to pay medical expenses that are not reimbursed by health insurance and exceed 10 percent of your adjusted gross income for the year (if you’re under 65). 

As with the other exceptions, you’ll owe taxes on all withdrawals from a traditional IRA, even if you’re exempt from the penalty, and on earnings withdrawn from a Roth IRA. You can also use money to cover the cost of childbirth or adoption expenses, up to $5,000, without paying a penalty. (Again, if you tap your Roth IRA earnings, you’ll want to be sure you started contributing to the account at least five years ago to avoid paying the penalty.)

Should I use my IRA to save for these expenses?

Buying a first home, paying for college and covering unexpected medical expenses are all important and significant costs. That’s why the IRS allows people to withdraw from their IRAs for these purposes, without penalties. 

But just because you can do it doesn’t mean an IRA is the best way to save and plan for these costs. For example, if you’re purchasing or building your first home, the $10,000 you’re allowed to take from your IRA without penalty is unlikely to go very far, especially if you live in an area with high property values. 

While you can use an IRA to save for college expenses and avoid the 10 percent penalty, it may not be the best way to save. That’s especially true if you expect to use the funds for college before you reach age 59 ½, as you’ll be required to pay taxes on the entire distribution from a traditional IRA and on the earnings portion of your distribution from a Roth IRA. Instead, a 529 plan, which is expressly designed for college savings, allows tax-free withdrawals on the earnings at any age, as long as the funds are used for qualified education expenses.   

And while the IRA exception for healthcare expenses may come in handy if you experience high-dollar medical costs, a health savings account could be a better option. If you have a high-deductible health plan, you can make tax-free contributions to an HSA, and all withdrawals are tax free when used for qualified medical expenses. 

The bottom line is that the funds in your IRA are intended to help you have a more comfortable, financially secure retirement. When you withdraw funds before you reach retirement age, even if you won’t owe a penalty, you’re losing the opportunity to continue earning on that money and building a more robust retirement nest egg.