There are many advantages to choosing a life plan community (also called a continuing care retirement community or CCRC), including a wide range of amenities and services that make retirement easier and the availability of a full continuum of on-site care if needed. If you’re thinking about moving to a CCRC, one important question is how to handle the financial side of the move—specifically, “How should I pay the CCRC entry fee?”
Many retirees who choose an entry-fee community use proceeds from the sale of their home to cover some or all of the entry fee. But what if you don’t own a home, or the net proceeds from a sale aren’t enough? Is it sensible to withdraw money from an individual retirement account (IRA) to cover the gap?
This article does not provide personal financial advice. Always consult a financial professional and a tax advisor about your own circumstances before making decisions. Below are important considerations and lesser-known effects of withdrawing from an IRA to pay an entry fee or for any other purpose.
Withdrawals from IRAs and other tax-deferred accounts
Withdrawals from traditional IRAs (and most other tax-deferred accounts) are taxed as ordinary income, unless you previously made after-tax contributions. The tax owed on a withdrawal depends on your Adjusted Gross Income (AGI) for the year you take the distribution.
For example, suppose you file jointly and your AGI before any IRA withdrawal is $70,000. Under the progressive U.S. tax system you pay lower rates on the initial portions of income and higher rates on income above each bracket threshold. In this example your effective tax rate might be around 11.5% on that $70,000.
Now imagine withdrawing $300,000 from an IRA to pay a CCRC entry fee. If no after-tax contributions exist in the account, the full $300,000 is taxable as ordinary income and could push your taxable income into a much higher tax bracket. Although you won’t pay the top bracket rate on all income—only on the income above the bracket threshold—your effective tax rate for that year would rise substantially. If you are under age 59½, an additional 10% early-withdrawal penalty may apply.
Withdrawals from other tax-deferred accounts, such as tax-deferred annuities, may also be taxed as ordinary income. Annuities differ because only the gain portion is taxable; contributions (the cost basis) are not taxed at withdrawal. However, if the annuity is inside an IRA, the IRA rules govern and the full withdrawal is generally taxable.
Potential Medicare surcharges
Large distributions from IRAs can create additional costs beyond income tax. One example is the Income-Related Monthly Adjustment Amount (IRMAA) that increases Medicare Part B premiums for higher-income beneficiaries. These surcharge thresholds are based on your income and can substantially raise monthly Medicare premiums and Part D costs for those above certain Modified Adjusted Gross Income (MAGI) levels.
For couples, IRMAA surcharges begin at certain MAGI levels and increase with higher income. A key factor is that Medicare looks back two tax years when determining IRMAA, so a large IRA withdrawal in one year can lead to higher Medicare premiums two years later.
Withdrawals from taxable (non-IRA) accounts
Withdrawing the same amount from a taxable brokerage account (stocks, bonds, mutual funds, cash, etc.) typically triggers capital gains tax on any gains realized when you sell investments to generate cash. Long-term capital gains rates are generally lower than ordinary income rates, and you can manage the tax impact by choosing which holdings to sell and harvesting losses to offset gains.
For instance, if you sell holdings that produce a $200,000 long-term capital gain to generate a $300,000 withdrawal, that gain may be taxed at favorable long-term capital gains rates (often 0%, 15%, or 20% depending on overall income). In many cases, that results in a significantly lower federal tax bill than taking the same amount from a traditional IRA. Using taxable accounts can also reduce how much the withdrawal increases your AGI compared with an IRA distribution, which may lower the IRMAA impact.
Net Investment Income Tax (NIIT)
Another consideration is the Net Investment Income Tax (NIIT), a 3.8% tax that applies when MAGI exceeds a certain threshold. The NIIT applies to investment-related income, including capital gains, so a large withdrawal from a taxable account that creates significant capital gains can trigger NIIT. If your MAGI exceeds the NIIT threshold, plan for this additional surcharge in your overall tax calculation.
Even when the NIIT applies, withdrawing from a taxable account can still be tax-advantaged relative to taking a large IRA distribution because capital gains rates and the ability to offset gains with losses often result in a lower total tax bill.
Practical considerations when funding a CCRC entry fee
Choosing which account to use for a large one-time expense like a CCRC entry fee depends on many factors: the tax consequences of each account type, your age (and potential early-withdrawal penalties), the impact on Medicare premiums and IRMAA, state tax rules, and your overall financial plan. Taxable accounts allow more flexibility and tax management through selective sales, while IRA distributions increase ordinary income and can push you into higher tax and Medicare surcharge brackets.
Because individual circumstances vary widely, these general points are intended to help you understand the trade-offs between withdrawing from an IRA versus a taxable account. Consult your financial planner and tax advisor to evaluate your specific situation and to explore other options for funding the entry fee. Future discussions can cover alternative funding strategies and possible tax deductions related to some CCRC entry fees.