End of IRA Discrimination Is in Sight for Home Buyers
Should millions of Americans with Individual Retirement Accounts, or IRAs, be discriminated against by the federal government when it comes to financing a home?
Should their $2 trillion in savings be effectively kept off-limits for home buying for themselves or a family member?
Sounds like a no-brainer, yet it’s a fact:
If you are an IRA account holder, you cannot borrow money from your retirement plan to buy a home yourself--or to help a child or grandchild buy a home--without paying federal income taxes.
Yet most Americans who participate in employer-sponsored 401(k) retirement plans can readily pull out cash tax-free any time to help a relative buy a home.
Why the discriminatory treatment?
Experts on Capitol Hill say it’s partly the result of separate evolutionary tracks for different types of federally regulated pension accounts.
In the case of IRAs, according to one aide, Congress was concerned in past decades that account holders might be tempted to “self-deal” their tax-deferred retirement savings, using funds for speculative real estate investments and other high-risk ventures.
To deter such abuses, Congress imposed a 10% penalty on most “premature” withdrawals (before the age of 59 1/2) from IRA accounts and required account holders to pay income tax at their regular rate on the amounts withdrawn.
Other types of retirement accounts--including private employer 401(k) plans and the federal government’s own retirement-savings plans for its employees--traditionally have allowed penalty-free borrowing by participants up to specified dollar limits.
In 1997, Congress moved part of the way to rectifying the disparate treatment of IRA accounts by eliminating the 10% penalty for IRA holders who withdraw up to $10,000 for a home purchase. But IRA holders who make home-related early withdrawals still have to pay income tax on whatever they pull out.
That means that a taxpayer in the 28% federal bracket who wants to help a son or daughter buy a first home could pull out $10,000 from an IRA, but would owe the federal government $2,800 for the privilege.
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The son or daughter, in turn, would net $7,200, not the full $10,000 that he or she would get if mom or dad were tapping a 401(k) account.
But legislative help may be on the way. Key members of the House and Senate are sponsoring bills that would end the unequal treatment of IRAs for housing purposes.
Rep. John J. LaFalce (D-N.Y.), ranking minority member of the House Banking Committee, introduced the First-Time Homebuyer Affordability Act (HR 1333) before the Easter recess, with bipartisan support. An identical bill is expected to be introduced this month in the Senate by Sen. John F. Kerry (D-Mass.).
The bill would allow anyone with an IRA to withdraw up to $10,000 tax-free and penalty-free, provided it was loaned to a child, grandchild, spouse, parent or grandparent for the purpose of purchasing a “first-time” home.
“First-time” is generously defined by the bill to include anyone who hasn’t owned a principal residence in the 24 months prior to obtaining the IRA assistance.
Other important requirements for pulling out IRA housing cash tax-free under the bill:
* The money would have to take the form of an interest-bearing loan. In other words, you couldn’t simply pull out $10,000 and make it a gift to the home buyers.
* The loan would have to give the IRA account holder a legal “ownership interest” in the property to safeguard the retirement dollars.
* The term of the loan could be up to 15 years. Payments by the home buyer could be on a monthly, amortized basis (principal plus interest), or on an interest-only basis. The remaining principal would be due and payable when the house was sold, or the loan term was complete.
* The interest rate on the note would have to be no more than 2 percentage points above--or below--Treasury rates for securities with maturities comparable to the IRA loan.
If you arranged your withdrawal to meet all these tests, you could pull out $10,000 from an IRA penalty-free and tax-free.
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In a “Dear Colleague” letter drumming up support for the plan in the House, Rep. LaFalce said, “It is time to take [this] long overdue step” to remove the current “inequitable impediment to homeownership” in federal statutes.
LaFalce also argued that it would increase the amount of savings going into IRA plans. “Many young families and individuals,” he wrote, “are hesitant to tie up funds in an IRA account that they may need later to buy a house.”
The outlook for the bill: Good, especially if it can be attached to a larger piece of legislation heading for floor action this year.
After all, said one Capitol Hill aide, “Who’s going to oppose ending the discriminatory treatment of people with IRAs?”
Stay tuned.
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Distributed by the Washington Post Writers Group.
