Tax forms on clipboard with glasses and pen © topseller/Shutterstock.com

Dear Tax Talk,

I am 75 years old and just was terminated after 21 years with the same corporation. I have a 401(k) as a retirement fund, and accumulated about $300,000. Seven months ago (before I knew about my termination), my wife and I decided to extract $180,000 to pay off the mortgage of our only residence in preparation for retirement. We paid off our mortgage, using the money that remained after taxes on that $180,000.

I will be rolling the rest of that 401(k) into an IRA. We are working on our taxes for 2014. In addition to the 20% I paid when receiving the withdrawal to pay off our mortgage, the IRS is asking for another $15,000. I realize now that it might have been better if I had waited a couple of years after rolling over the 401(k), but the deed is done.

Question: Are there any tax loopholes available, because we, in effect, rolled the money into our home? Or do we just suck in our pride and acknowledge our mistake and pay some 28% on that withdrawal?

— Robert

Dear Robert,

You are correct. There is no tax loophole available for taking money out of your retirement account to pay off your mortgage. As you have already figured out after the fact, the income is added to your other income, which may throw you into a higher tax bracket, and the withholding that was taken out of the distribution does not cover everything owed to Uncle Sam.

You sent your question in on April 14, so I hope you went ahead and filed the return and paid the balance due. If, for some reason, you held back and extended your return and did not pay in the additional tax you owe, then file your return as soon as possible. Remember, an extension is only for filing the return; all taxes are due on April 15 or you incur interest and penalties.

IRS late fees are onerous!

  • If you don’t file your return, you will owe an additional 5% each month of any tax amount that is due, up to 25%.
  • If you don’t pay what you owe, the IRS will levy an extra 0.5% each month of your due tax amount to your overall IRS debt.
  • If you don’t file or pay, the 0.5% failure-to-pay penalty will accrue, up to 25% of what you owe, until the tax is paid.
  • That means the total penalty for failure to file and pay could amount to a whopping 47.5% of your tax bill!
  • On top of all that, you’ll owe interest on the overdue amount. Determined quarterly, the interest rate is the federal short-term rate plus 3%, compounded daily.
  • Other penalties may apply.

Source: IRS

I frequently see questions from people who are getting ready to retire and want to take money out of their retirement account to pay off their mortgage. It is a good idea to meet with a tax professional before making these decisions so you understand the ramifications of taking out large sums from retirement accounts at one time. Even though you were not subject to the additional 10% tax, you still had to report the income. They can help you figure out whether it is best to take your distribution amounts over several years in order to minimize the tax burden. Keep in mind that once you pay off the mortgage, there is no longer any interest deduction.

Thanks for the great question and all the best to you and your wife in your retirement years.

Ask the adviser

To ask a question on Tax Talk, go to the “Ask the Experts” page and select “Taxes” as the topic. Read more Tax Talk columns.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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.

Promoted Stories