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?

Thanks,

-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?

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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.

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