Homebuyer Can Tap IRA, Avoid IRS Penalty

Dear Retirement Adviser, 

I am looking to use some money from my traditional individual retirement account as a down payment on a home. I have read about the requirement to pay the 10% penalty on anything more than $10,000 plus interest. Is there a way to use the IRA funds to pay these taxes at the time of removal from the IRA? Do you have to pay this along with your annual income taxes?


-Taxing Tom

Dear Tom, 

That's a great question! If you qualify for the first-time homebuyer exemption, you won't owe the 10% additional tax on up to $10,000 used to purchase, build or rebuild the home if the money is spent for approved uses within 120 days of the withdrawal. But what about the regular income taxes due on the early distribution?

Compare Mortgage Rates in Your Area

From IRS Tax Topic 557, "Federal income tax withholding is required for distributions from IRAs unless you elect out of withholding on the distribution." If you elect to not have taxes withheld, then you may have to make quarterly estimated tax payments. Otherwise the tax payment is due when your annual income tax payment is due.

You can't, for example, take a distribution above $10,000 plus the 10% tax, use the $10,000 and avoid the additional tax. Also, don't forget about any applicable state income taxes due on the distribution.

If you need to tap the account for more than $10,000, then you must pay the 10% additional tax on the distribution as well as income taxes. If you want to fund the tax expense from the account, instead of taking it from savings, for example, remember you'll pay an additional 10% tax. Investment earnings, including interest, in your traditional IRA are subject to taxation, but you don't pay interest expense to the IRS.

Get more news, money-saving tips and expert advice by signing up for a free Bankrate newsletter.

Ask the adviser

To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "Financing a home," "Saving and Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.

Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.

Copyright 2013, Bankrate Inc.