Hello again Randy,
First, I would like to address some of the things you brought up as possibilities:
1. 5 year income averaging - this was disallowed a number of years ago by the IRS and is no longer an option execpt for people in the farming and fishing trades.
2. Buying your home inside of the IRA - this is not an option for an IRA investment.
3. Buying the home as an investment - this still does not reduce or eliminate any tax that you owe on your IRA withdrawals.
We have already established the fact that you will owe no tax on the sale of your current residence. So all the sales
proceeds that you receive from your current home can be used towards the new residence you wish to purchase. Since you would like to use the funds from your IRA account to do this, the question becomes how to minimize tax on those withdrawals.
The one basic thing that you must understand about IRA withdrawals, is that there really is no way to minimize tax on the withdrawals, other than to keep the withdrawals down to an amount each year where it keeps you in a lower income tax bracket. When you withdraw funds from your IRA account, those funds become taxable, regardless of what type of investment you use them for, so there is no other option for reducing your taxes on the withdrawals, other than to keep down the amount you withdraw each year, to a point where it keeps you in a low bracket.
In your current situation, you said you receive about $24,000 in SS benefits and another $11,000 from your employer's retirement plan. This would mean that none of your SS benefits are taxable at this point.
When you receive SS benefits, if that is your only source of income, then the benefits are not taxable. However, if you receive other income, including IRA withdrawals you make in a year, then part of your SS benefits may also be taxable, if your other income exceeds the allowed amount.
There is a formula which is used to determine if any of your SS benefits are subject to tax and here is how that works. As a married person, SS allows you a base amount of $32,000. You must then take half of what you receive in annual SS benefits and subtract that from the base amount. The result is what you are allowed to have in other income before any of your SS benefits are subject to tax. Since your SS benefits are currently around $24,000, then if we take half of that ($12,000) and subtract it from your base of $32,000, that means you could have an additional $20,000 in income each year without any of your SS benefits being taxable.
Right now you are receiving an extra $11,000 from your retirement plan. That means you could have another $9,000 in annual income without any of your SS benefits being subject to tax. That being the case, here is what I would suggest that you do.
If you sell your current home for $150,000 and purchase another home for $200,000, then take out a 5 year balloon note to finance the other $50,000 you will owe on the new home.
Each year, withdraw $9,000 from your IRA account. This is the amount you can still have in income without subjecting any of your SS benefits to tax. This would then give you total taxable income
for the year of $11,000 from your retirement plan and $9,000 from your IRA, for a total of $20,000. Since you are married you are allowed a standard deduction
of $11,900 plus exemptions for you and your wife of $3,6,50 each. That gives you total deductions
of $19,200 against your $20,000 income. That would then only leave you with taxable income for the year of $800, and your tax on that amount would be $80.
If you take out the $9,000 each year for the next 5 years, then at the end of the 5 year period, you will only owe another $5,000 on the home, and can pay off the balance in the 6th year. Each year that you do this you will owe no more in tax than $80.
The interest rate
that you would be paying on the 5 year balloon note should be no more than around 5.5% to 6%, and of course your principal amount will be reduced each year as you make annual payments of $9,000 on the note.
This is going to be the best way for you to minimize taxes on your IRA withdrawals.
There is one other thing that I would suggest. If you choose to go this route, then at the end of the 5 years, once your new home is paid for, I would continue to take yearly withdrawals from your IRA account of $9,000 each year, since it will only cost you tax of $80 to do this. Then take that $9,000 and roll it over in to a Roth IRA
account instead of a traditional IRA
Once you have the Roth IRA open, you never have to worry again about paying tax on that Roth IRA account. Any earnings that are made are totally tax free. So in future years when you make Roth IRA withdrawals, you owe no tax whatsoever. So your money still continues to grow tax free, and the money it earns is also free from tax. And you should definitely take advantage of making those $9,000 annual withdrawals since by doing so your tax bill is only $80 on the entire amount.
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Thank you again Randy, and let me know if you have more questions. I am happy to help you with whatever I can.