In the U.S., people drowning in the sea of debt often raise a question if they can clear their debt by using an IRA. Answering their question it is to be said that you are not allowed to borrow money against the IRA, nor allowed for a special exemption from penalties if you have a financial hardship. However, if the financial hardship is due to a qualified expense, such as college expenses or medical expenses exceeding 7.5 percent of your adjusted gross income, then you will be able to withdraw money from the IRA. This will be penalty free, but not necessarily tax free. You have to file the withdrawal amount on your taxes, depending on whether the IRA is a traditional IRA or Roth IRA.
Now let us have a look how to borrow money against the IRA and pay off the exiting debt.
- In order to withdraw money from the IRA, collect an IRA withdrawal form from your financial institution and use it. If you intend to use the money toward paying off the debt that meets the standards for a qualified withdrawal, make sure you note that down on the withdrawal form.
- Remember, you must follow the proceeds of the IRA distribution to pay off the debt. Also remember to keep accurate records and receipts of the money contributed towards expenses that make it a qualified distribution. These records and receipts can serve as a proof when your tax return is questioned.
- In order to determine whether you owe any taxes on your return, fill the first part of the IRS form 5329. Then report the total amount of the distribution on line 1, the amount that is qualified on line 2, and the difference on line 3. If you see any portion on line three that is unqualified then multiply it by 10 percent to calculate your tax penalty and report it on line 4.
- If there is any amount of penalty, then copy that to line 58 of your form 1040 of tax return.
- Then write the total amount you withdraw on line 15a of your form 1040 tax return. Also write the taxable amount on line 15b of the form 1040 tax return. Remember, in case you withdraw money from a traditional IRA, you have to include the amount as taxable income, even if you do not have to pay an early withdrawal penalty. On the other hand, in case you withdraw from a Roth IRA, you do not have to include the amount as taxable income since it is usually non-taxable.
Hence, to conclude, bear the above mentioned steps in mind to withdraw money from the IRA and to pay off all your debt.