IRA deposit for tax savings with purchase of house coming up?

Question

I just did my taxes and my maximum IRA contribution of $4,000 adds $600 onto my federal return.

If I clear out the IRA (all $4,000) tomorrow wouldn't I pay only the 10% penalty of $400? Or would I have to pay the penalty and then other taxes (capital gains?) on top of it?

Another question. I might be purchasing a house soon. So could I deposit $10,000 now: get deductions of $4,000 for 2006, $4,000 for 2007, $2,000 for 2008? Would I get those deductions even if I withdrew all $10,000 for a 1st time home purchase in May or June of this year?

Is there anything I'm missing here, or other requirements I should know about?

Answer 1

No, you wouldn't just pay the penalty, you'd also pay tax at ordinary income rates - IRA withdrawals don't qualify for capital gains rates.

You could deposit money now and get deductions for 2006 and 2007, not for 2008 - you can just make contributions for the current year, or for the previous year up until the filing deadline. Then you could take the money out without penalty, but would still pay tax at ordinary income rates when you file your 2007 return, so any savings on the contribution for 2007 would be a wash since you'd owe 2007 taxes on the withdrawal - you'd deduct $600 for an IRA contribution but add $600 for IRA withdrawal. For the 2006 contribution, you would save a little since you'd essentially defer taxes on that amount for a year, but your savings would only be any gain on the $600 you took off of this year's tax return, so would probably only be a few dollars.

Answer 2

If you cleared out the IRA tomorrow, you'll pay tax on the full amount of the distribution on your 2007 return. The distributon would be taxed as ordinary income at your marginal rate. It is not treated as a capital gain however that's irrelevant since a short term CG would be taxed at the same amount. If you used the proceeds for the purchase of a first home you could avoid the 10% penalty tax.

Since you cannot contribute more than $4,000 for 2006 ($5,000 if age 50 or over) the rest of your question is irrelevant.

If you chose to make contributions in any other years those would stand on their own. Clearing the account tomorrow would close the account anyway but if you did leave enough in there to keep it open, your emptying the account now would not affect the contributions in future years.