We used our IRA to buy a house for cash. Should we borrow to pay off the IRA or take the tax hit?

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Homebuyers used a retirement loan to buy their home and asked the Credible Money Coach if they should bear the tax instead of paying off the loan. (Credible)

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Dear credible money coach,

We paid cash for our house, but withdrew $ 200,000 from an IRA to help with the cash transaction. The $ 200,000 is expected to be repaid within 60 days, or there will be a 10% tax due in April.

We could apply for an equity loan to pay it off now, or wait until April and save enough to pay the 10% tax. All of our income is tax free, so the only tax will be $ 20,000 (10% of $ 200,000). Our annual tax-free income is approximately $ 75,000.

What would be the best alternative? – Jan, Nevada

Hi Jan! Thank you for your question and for providing us with additional information in response to our email. Your question is interesting and unusual! While I will do my best to share with you what I know about the tax rules that seem to apply to your situation, I strongly recommend that you consult with a trusted tax professional before deciding how to proceed.

First of all, congratulations on paying cash for your house! Not having a mortgage payment is a huge financial benefit, especially as you approach retirement age – as you told us, you’re over 59 and a half.

You also told us that the house you bought was for $ 590,000 – $ 390,000 was from savings and $ 200,000 from a SINGLE IRA. And, from the additional information you provided, it appears that you generally don’t owe state or federal income tax on your $ 75,000 income. Keep in mind that any income you do not pay tax on may still be considered taxable, at least federally – Nevada, where you live, has no state income tax. .

So, to answer this question, we need to focus on the federal tax implications.

What the IRS Says About IRA Withdrawals

The idea behind tax-efficient retirement accounts like a SINGLE IRA is that you put money into your retirement account when you are actively earning and are in a higher tax bracket. Then, when you retire and are no longer an active employee, your tax bracket will likely be lower and you will pay less tax on the money than you would have paid while you were still working.

The money you withdraw from a SINGLE IRA is not considered a loan. This is considered a withdrawal and this amount will generally be subject to federal income tax. But you may be able to put that money back into your IRA and avoid the tax implications in certain circumstances.

Generally, you can withdraw money from a SINGLE IRA and not pay tax if you transfer that money to another IRA within 60 days. And, because the IRS recognizes that people sometimes change their mind about opening a new IRA, you can usually put the money back into the original IRA within 60 days and avoid federal tax. on income on the amount.

Tax implications of IRA withdrawals

Keep in mind that when you put money into the IRA, it was pre-tax, so you usually have to pay tax on it when you withdraw it. That said, not all money withdrawn from an IRA is considered taxable and the rules for determining what is and what is not are quite complex.

The 10% you referred to in your original question is actually a penalty that generally applies, in addition to ordinary income tax, if you withdraw money before you are 59 and a half years old. Since you have exceeded this age threshold, this penalty should not apply in this case. So the amount you might owe would not be $ 20,000 – 10% x $ 200,000.

You might owe more, and here’s why.

Your $ 200,000 withdrawal will likely be considered taxable income if you do not return it to your IRA by the required time, even if your other income has not been subject to federal income tax in the past. The tax rate that will apply to your withdrawal will be calculated based on your total income for 2021, including your regular income of $ 75,000, the withdrawal of $ 200,000 and any other taxable income you receive that year.

Based on this information, it’s probably a good idea to return the $ 200,000 withdrawal to your IRA within 60 days – or you could face a large tax bill in April 2022. And, since the IRS expects you to pay at least 90% of the tax you owe in a given year before the tax deadline for that year, if the tax you owe is more than 10% of your total tax liability, you may be subject to an underpayment penalty.

Reimbursement options

You asked if you should take a home equity loan for $ 200,000 to repay the money you have withdrawn from your IRA. This can be an option if you can find a lender willing to leverage that much equity.

Typically, lenders will allow you to borrow up to 85% of the value of your home, less anything you owe on a mortgage. Since you don’t have a mortgage, your home equity is $ 590,000, and 85% of that value is $ 501,500 – far more than you would need to borrow to pay off your IRA withdrawal. . Of course, other factors will also come into play when a lender is deciding how much to lend you.

Based on the range of scores you shared with us, I would rate your credit as good to excellent, and you may be able to qualify for a favorable rate on your home equity. Right now, interest rates are low overall, but home equity loan rates can vary widely depending on the lender, your credit, and a host of other factors.

If you decide to go this route, be sure to comparison store for loans from several lenders to improve your chances of finding the best interest rate and the best possible loan deal.

One last word…

As I said at the start of this column, it’s a good idea to consult a tax professional whenever you encounter a situation that could have significant tax consequences. Consult with your accountant or other financial advisor you trust to discuss options that will minimize the impact on your taxes and your overall financial well-being.

Need Credible® advice on a money issue? Email our credible money coaches at [email protected]. A Money Coach could answer your question in a future column.

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About the Author:

Dan Roccato is a Clinical Professor of Finance, School of Business, University of San Diego, Credible Money Coach personal finance expert, published author and entrepreneur. He has held leadership positions with Merrill Lynch and Morgan Stanley. He is a recognized expert in personal finance, global securities services and corporate stock options. You can find it on LinkedIn.

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