Dear Dr. Don,
I plan to take $115,000 from my individual retirement account to buy a home, which will be my primary residence. I am 67 years old and a first-time homebuyer. Will the $115,000 be tax-free?
-- Anna Abode
Dear Anna,
The first-time homebuyer exemption in an IRA lets someone who qualifies for the exemption to withdraw money from his or her account without penalty. That means he or she avoids the 10 percent penalty tax levied on early distributions from an IRA. And the early distribution penalty ends at age 59½, so you wouldn't owe any penalty.
That doesn't mean you wouldn't owe any taxes. Contributions made to an IRA funded with pretax income are taxable income when the money is distributed. Taking out $115,000 in one calendar year is likely to raise your marginal federal income tax bracket. The Bankrate chart on tax brackets will help you determine if that big withdrawal will raise your tax bracket. Odds are that it will.
If you can qualify for a mortgage loan, it may be a better strategy to finance the home with a mortgage that doesn't have a prepayment penalty and pay down the mortgage over the next few years, managing the impact that the IRA distributions would have on your tax bracket. Work with your tax professional if you can't decide on your own that this strategy makes sense.
I like the idea of owning a home free and clear in retirement. I just think it's better to pay some interest to avoid a big increase in your income taxes.
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