Q: Should we cash out our IRA for a down payment on a great deal of a house? It is a short sale in a great area; so, we would have 20% to put down and avoid PMI and get a 4.75% interest rate?
A: For those who don’t know—and there are many—let me explain what an IRA is. An individual retirement arrangement, or IRA, allows you to set aside money for retirement with some tax advantages. You may be able to deduct some or all of your contributions to your IRA. Your contributions and earnings generally are not taxed until distributed to you. However, if you take the money out before reaching age 59½, you may be subject to a 10% additional tax.
However, recognizing that people have limited savings, there are exceptions to the 10% penalty rule. Here are some of them:
- You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
- You are disabled.
- You are the beneficiary of a deceased IRA owner.
- The distribution is due to an IRS levy of the qualified plan.
- The distribution is a qualified reservist distribution.
- You use the distributions to buy, build or rebuild a first home.
As for the first home, you do not have to pay the 10% penalty on up to $10,000 ($20,000 if you are married) of distributions you receive to buy, build or rebuild a first home. Generally, you are a first-time homebuyer if you had no present interest in a primary home for the previous two years. If you are married, your spouse must also meet this no-ownership requirement.
I should note, your withdrawal is still taxed at your current marginal tax rate.
Before using the IRA money, read IRS Publication 590 “Individual Retirement Arrangement (IRAs).”
Now, having provided the background and the facts, let me give you my opinion. I would do everything in my power to avoid tapping this money.
Even without the 10% penalty, you’re hitting up the fund you specifically set up for retirement. While homeownership is a worthy goal, you shouldn’t do it with money intended for your retirement. If it were me, I’d wait and save up the money. Besides, if you’re like many right now, your IRA investments are probably way down. You’ll be locking in losses on top of having to pay tax on the money.
But, if you are dead set for taking this money, be sure the mortgage is affordable and you can quickly rebuild your retirement account.