Roth Distribution for new home construction

Submitted by Julie Brangenberg on Fri, 2015-04-24 15:04

Hello.

Customer (30 yrs old) has a Roth IRA that he funded. He is getting ready to build a new home. I don’t think this is his first home purchase. Will he be penalized on the earnings withdrawal?



Submitted by Julie Brangenberg on Fri, 2015-04-24 16:42

Here are a few more details.Roth was established in 2012 from a rollover from a traditional and a new contribution. This will be client’s 1st home purchase. 

Submitted by Alan - IRA critic on Fri, 2015-04-24 18:00

  • Assuming customer qualifies as a first time homebuyer, he would withdraw up to the amount of his regular contributions tax and penalty free. Next out would be conversions tax free, and the first home exception would waive the 10% penalty on up to 10,000 of the conversion money.
  • If he needs to drain the entire Roth, he cannot qualify for 10,000 of the earnings to be distributed tax and penalty free until 2017. But even if he waited until then, he still will have only 10,000 available for the first home exception, so he might as well use that exception to waive the 10% on up to 10,000 of the conversion money, unless the distribution will not be made until 2017. 2017 is when his Roth meets the 5 year holding period for qualified distributions of earnings up to 10,000.

Submitted by Julie Brangenberg on Fri, 2015-04-24 18:26

Can u elaborate on the rule for conversions…  Does the client have a 5 year wait on it?

Submitted by Alan - IRA critic on Fri, 2015-04-24 18:49

Yes, like any Roth conversion, 5 years must pass before the conversion can be distributed penalty free. But a qualified first home purchase penalty exception can be used to waive up to 10,000 of the amount subject to penalty. In 2017, the 2012 conversion would have met the 5 year holding period, so the entire 2012 conversion would come out penalty free without using the exception. And since his first Roth contribution of any kind was in 2012, 2017 is also the year the 5 year holding period for earnings up to 10,000 to be distributed tax and penalty free is satisfied. Note that if client is married and the spouse also has an IRA, the spouse also has 10,000 to use from their own IRA accounts, however a spouse can also complicate the first home qualification requirements. First home options are the most complex of the Roth IRA rules. The balance and composition of the Roth and the amount of distribution needed is where to start in considering how to approach the first home benefits.

Submitted by Julie Brangenberg on Fri, 2015-04-24 19:21

So, the client can take the contribution and the conversion without any tax or penalty assuming the first home purchase is qualified.  The earnings will have to wait until the 5 year holding period is satisfied.

Submitted by Alan - IRA critic on Fri, 2015-04-24 19:41

Yes, but if the conversions withdrawn are more than 10k, there will still be a penalty on the amount in excess of 10k.

Submitted by Julie Brangenberg on Thu, 2015-04-30 15:02

The client is planning to take the contribution and conversion only.  He is planning to start construction in summer or fall.  Can he take the distribution now, or should he wait until closer to acutally needing the money, or does it just have to be in the same year as use?

Submitted by Alan - IRA critic on Thu, 2015-04-30 18:13

Client must pay the costs no later than 120 days after receipt of the distribution. Since construction schedules are subject to frequent delays, the distribution should not be taken too soon. If taken too soon, at 120 days he would have to prepay some costs and that might not be a good idea. If the contract were to be cancelled, client also has up to 120 days from the distribution to roll the funds back into the IRA and a rollover for this reason does not count against the one rollover limit per 12 months.

Add new comment

Log in or register to post comments