Tax Credit for IRA Withdrawals to Avoid Foreclosure
Original post by Alexis Lawrence of Demand Media
Though people generally put money into an individual retirement account, or IRA, to save for their golden years, circumstances may arise before retirement age that necessitate the early withdrawal of funds from the account. In certain instances people can avoid the penalty that comes with early withdrawal from an IRA prior to age 59 1/2, but avoiding foreclosure isn't one of them.
What Qualifies for No Penalty
The few instances in which you can make an early withdrawal from an IRA with no penalty are considered "hardship withdrawals." These withdrawals include money needed for medical expenses that exceed 7.5 percent of your adjusted gross income on your tax return; money needed to buy a first home, or rebuild a first home due to unforeseen circumstances, such as fire; or a change in financial circumstances due to becoming disabled. Education expenses may also qualify if you have exhausted all other options and have no other way to cover education costs.
The Early Withdrawal Penalty
Nearly all other circumstances in which you would need to make an early withdrawal from your IRA to pay for expenses are subject to an early withdrawal penalty of 10 percent. This includes money needed to avoid foreclosure on a primary home or another property. This 10 percent penalty is generally issued when you pay taxes, so if you withdraw $50,000, you can expect to have an additional $5,000 to pay at tax time. You'll also have to pay taxes, at your regular income tax rate, on the $50,000 withdrawal.
How Early Withdrawal Affects Your Taxes
While it may seem like you should receive a tax credit for an early withdrawal from an IRA due to hardship, no such tax credit exists. In fact, when you withdraw money from your IRA, even to avoid foreclosure, you must declare the money that you withdraw from the IRA as income on your tax return. This is due to the fact that the money in the IRA was contributed pre-tax, so you technically still owe taxes on that original income.
Penalty Free 60 Days
If you want to avoid the 10 percent penalty that comes with withdrawing money from your IRA early, and avoid paying taxes on that money, you do have one penalty-free option. You can withdraw the money from your IRA to pay the bank and avoid the foreclosure and then put the money back into your IRA within 60 days. You must be able to pay the money back within the 60 days though. If you don't put the money back, you must declare it and take the penalties.
Although a traditional retirement account is funded prior to taxation, a Roth IRA accepts post-tax contributions. Since these contributions already have the taxes taken from them, the money won't be taxed again when you withdraw it. You can withdraw the contributions that you made to a Roth IRA at any time with no penalty, provided the account has been open for at least five tax years. You may not, however, withdraw interest made on those contributions without penalty. Like with a traditional IRA, Roth IRA earnings may be withdrawn only in certain circumstances, and, if you withdraw earnings, you are subject to taxation and penalties.
- Bankrate; Pay IRA Penalty or Foreclose; George Saenz; September 2009
- Orange County Register; Early Withdrawal Penalties on IRAs; Mary Ann Milbourn; February 2011
- Bills; Early Withdrawal Tax Penalty; January 2008
- Fairmark; Roth IRA 101; Kaye A. Thomas; April 2011
About the Author
Alexis Lawrence is a freelance writer, filmmaker and photographer with extensive experience in digital video, book publishing and graphic design. An avid traveler, Lawrence has visited at least 10 cities on each inhabitable continent. She has attended several universities and holds a Bachelor of Science in English.