We tapped our IRA to buy a house for cash. Should we borrow to pay back the IRA or accept the tax loss?

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Credible Money Coach Dan Roccato (Feature) (Credible)

Credible Operations, Inc. NMLS # 1681276, “Credible.” Not available in all federal states. www.nmlsconsumeraccess.org.

Dear credible money coach,

We paid cash for our house but withdrew $ 200,000 from an IRA to help with the cash business. The $ 200,000 should be paid back in 60 days or 10% tax will be due in April.

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

Which would be the best alternative? – Jan, Nevada

Hello Jan! Thank you for your question and for providing some additional information to you in response to our email. Your question is interesting and unusual! While I will do my best to provide you with my knowledge of tax regulations that appear to apply to your situation, I strongly recommend that you consult a trusted tax professional before deciding how to proceed.

First of all, congratulations on paying cash for your house! Not having to pay a mortgage is a huge financial asset, especially as you are nearing retirement age – as you told us, you are over 59½.

They also told us that the house you bought was $ 590,000 – $ 390,000 came from savings and $ 200,000 from a SIMPLE IRA. And from the additional information you provided, it seems like you normally don’t owe any state or federal income tax on your $ 75,000 income. Remember, any non-taxable income on can be considered taxable at least at the federal level – Nevada, where you live, has no state income taxes.

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

What the IRS Says About IRA Withdrawals

The idea behind tax-deferred retirement accounts like a SIMPLE IRA is that you put money into your retirement account when you are actively earning and in a higher tax bracket. Then by the time you retire and are no longer in employment, your tax bracket will likely be lower and you will pay less tax on the money than you would have paid when you were there.

Money you take from a SIMPLE IRA is not considered a loan. It’s considered a withdrawal, and that amount is generally subject to federal income tax. But you may be able to deposit that money back into your IRA and avoid the tax implications in certain circumstances.

In general, you can withdraw money from a SIMPLE IRA and pay no tax on it if you transfer that money to another IRA within 60 days. And since the IRS recognizes that people sometimes change their minds about opening a new IRA, you can usually put the money back into the original IRA within 60 days and avoid federal income tax on the amount.

Tax implications of IRA withdrawals

Remember, when you deposit money into the IRA it was before tax, so it is generally expected that you will pay tax on it when you withdraw it. That said, not all funds withdrawn from an IRA are considered taxable, and the rules for determining what is and what is not are quite complex.

The 10% you refer to in your introductory question is actually a penalty that is usually on top of regular income tax if you withdraw money before you are 59½ years old. Since you are over this age limit, this penalty should not apply in this case. So the amount you could owe wouldn’t be $ 20,000 – 10% x $ 200,000.

You could owe more, and here is why.

Your $ 200,000 payout will likely be considered taxable income if you don’t send it back to your IRA in the required timeframe – even though your other income has not been subject to federal income tax in the past. The tax rate on your withdrawal is 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 received that year.

Based on this information, it’s likely a good idea to return the $ 200,000 payout to your IRA within 60 days – or you could face a significant tax bill in April 2022. And since the IRS expects you to pay at least 90% of the tax you owe in any given year by the tax filing deadline for that year, the tax you owe is more than 10% of your total tax liability, you can get one Penalty for shortfalls may be imposed.

Repayment options

You asked if you should take one out Home loan for $ 200,000 to repay the money withdrawn from your IRA. This can be an option if you can find a lender who will allow you to get that much equity.

Generally, lenders allow you to borrow up to 85% of the value of your home, minus the mortgage debt. 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 back your IRA withdrawal. Of course, other factors also play a role in when a lender decides how much to lend you.

Based on the rating range you shared, I would say your credit rating is good to excellent and you may qualify for a cheap home equity ratio. Right now, overall interest rates are low, but home loan interest rates can vary widely depending on the lender, your credit, and a variety of other factors.

If you choose to go this route, take care Comparison shop for loans from several lenders to improve your chances of finding the best possible interest and loan agreement.

One last word …

As I said at the beginning of this column, it is a good idea to consult a tax advisor whenever you find yourself in a situation that could have significant tax implications. Contact your accountant or other trusted financial advisor to discuss options that will minimize the impact on your taxes and overall financial wellbeing.

In need of credible advice on a money question? Email to our Credible Money coaches [email protected]. A money coach could answer your question in an upcoming column.

This article is intended for general information and entertainment purposes. Using this website does not create a professional customer relationship. Any information found on or derived from this website is not a substitute for legal, tax, real estate, financial, risk management or other professional advice and cannot be viewed as such. If you need such advice, please contact a licensed or knowledgeable professional before taking any action.

About the author:

Dan Roccato is a clinical professor of finance at the University of San Diego School of Business, Credible Money Coach, an expert in personal finance, a published author, and an entrepreneur. He has held executive positions at Merrill Lynch and Morgan Stanley. He is a recognized expert in personal finance, global investment services, and corporate equity options. You find him LinkedIn.

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