Reader Question: My husband and I are in our mid-forties. I’ve been out of work since Oct 2015 and in November 2016 I taped into my IRA for $20,000. I’m still unemployed and in need of money for home improvements. Will it be wise to get another $10,000 out of my IRA for my home? My husband’s s total income is about $65,000. A.P.
Answer: Withdrawing money from a retirement account prior to age 59 ½ is rarely a good financial move since you’ll face two forms of taxes. The first is income taxes as any withdrawals will be treated as ordinary income and added on top of your husband’s income and taxed at your (family, assuming a joint tax return) highest marginal tax rate. Secondly, since you are under age 59 ½, you’ll face a 10% federal penalty. So, the cost of getting money out of a retirement plan early is very high. A mistake a lot of people make is taking an early withdrawal from their IRA, spending the money, and not having the cash when it’s time to pay the taxes and penalty.
You can avoid the 10% early withdrawal penalty by using a special rule: Substantially Equal Periodic Payments (SEPP). In general, you would take payments from your IRA based on your life expectancy (calculated from IRS tables). Once you begin payments, at the later of five years or reaching age 59 ½, you may discontinue taking payments and you will have avoided the penalty. Generally, I do not recommend this strategy because it’s a bit complicated and you’ll still face income taxes on the periodic payments.
I realize that sometimes there is an urgent need and there’s just no other source of funds other than your IRA. But first, consider all of your options:
- Get a Home Equity Line of Credit (HELOC). Particularly since you plan to use to money for home improvements, a HELOC is a good choice if it’s available. Interest payments on a HELOC should be deductible. Interest rates are typically very competitive and closing costs are often very low. Check around with several banks for the best deal.
- Postpone renovations. If the renovations aren’t urgent, considering saving money until you have the necessary cash. The catalyst for a new source of cash could be you landing that next job!
- Sell and downsize. Look around at other properties. Sometimes the best solution is to sell your present home and find something less expensive that is in good conditions (no repairs needed).
- Loan from your 401k. Not my favorite idea but much better than an early withdrawal. The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less. The good news is that the interest you are paying is to yourself!
- Credit cards. Bad idea. Let’s avoid this one!
If after considering all of your options, you simply cannot avoid taking money from your IRA, be sure you set aside an appropriate amount for the income taxes and penalties. The last thing you want to do is pick a fight with the IRS! Be sure to consult with your CPA before you take action.