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Dear Tax Talk,
Is it wise to withdraw money from an IRA before age 59½ for education purposes or buying a home? Should I get a loan instead? What are the rules for IRA withdrawals?
Generally, an IRA withdrawal before age 59½ incurs a penalty of 10 percent in addition to income tax. For some people this can be as much as 50 percent, so it doesn’t make a lot of sense. One of the advantages of the tax code is that for general rules, there are exceptions. Exceptions exist to encourage some sort of economic behavior, two of which, in this case, are purchasing a home and facilitating higher education.
In the case of a first-time home purchase, you can withdraw up to $10,000 penalty-free from your IRA. Certain criteria exist as to timing and eligible expenses. You can review these details in IRS Publication 590 on page 53.
Similarly, you can withdraw from your IRA penalty-free to pay qualified higher-education expenses not otherwise covered by grants. The expenses can be for yourself, your wife, children or grandchildren. See page 52 of Publication 590 to determine what are considered eligible expenses.
While the penalty is forgiven, income tax is due on the withdrawal. However, since home mortgage interest and taxes as well as higher-education expenses are tax-favored deductions or credits, part, if not all of the tax on the withdrawal can be offset.
Consult a CPA for assistance in proper planning to minimize or eliminate the income tax consequences of the IRA withdrawal.
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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.