Does Taking Money Out of Your IRA to Pay Off Your Home Incur a Tax Penalty?

by Leslie McClintock

When Congress designed the individual retirement arrangement, or IRA, in 1974, its intent was that workers would use these accounts specifically to ensure their own economic security in their retirement years. This is the purpose for the 10 percent penalty on withdrawals from IRAs prior to age 59 1/2.

Exceptions to the 10 Percent Penalty

The IRS allows you to make withdrawals from an IRA prior to age 59 1/2 without incurring a 10 percent penalty in the case of disability or death, if you inherit an IRA or to make a down payment on a first time home purchase of up to $10,000 for yourself or a family member. You can also avoid the penalty by paying for college expenses for yourself or a family member. However, you will not avoid the penalty if you use the distribution proceeds to pay off a home you already own.

Other Hardship Circumstances

You can avoid the 10 percent penalty if you make the withdrawal to avoid eviction or foreclosure, or to pay medical bills, but only to the extent they exceed 7.5 percent of your income, and to pay health insurance premiums, up to the dollar amount of those premiums for that year. The withdrawal will be subject to federal and state income tax.

Roth IRA Withdrawal Rules

Withdrawals from a Roth IRA incur a similar 10 percent penalty, but only on the gains in the account. You already paid taxes on your initial contribution. The age limit is the same -- 59 1/2. However, to qualify to pay the tax and penalty only on the gains, rather than the entire withdrawal, you must have left your principal in the account for at least five years. Otherwise, the entire amount is taxable and, if you are younger than age 59 1/2, subject to the 10 percent penalty.

Considerations

If you are paying off the mortgage on your personal residence, your interest is generally tax deductible. This means the after-tax cost of your home loan is substantially lower than the interest rate on the loan. Meanwhile, your IRA enjoys specific tax advantages, such as deferral of income taxes and capital gains tax. The law also provides substantial protection to your IRA from creditors. The assets in the IRA may also provide a diversification benefit -- cushioning your loss if the value of your home should fall.

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