Should I Pay the CCRC Entry Fee From My IRA?

There are many advantages to choosing a life plan community (also known as a continuing care retirement community or CCRC) including an array of amenities and services to make your retirement carefree, plus access to a full continuum of on-site care services, if needed. If you’re considering a CCRC, you may have questions around managing the financial aspects of this senior living decision, including, “How should I pay the CCRC entry fee?”

Retirees who move to an entry fee retirement community (such as a life plan community) often utilize the proceeds from the sale of their home to cover most or all of the entry fee. But what if you don’t own a home or if the net proceeds of your home sale are not quite enough to cover the entry fee? In that case, is it wise to withdraw money from your individual retirement account (IRA) to cover the gap?

Nothing in this post should be considered personal financial advice. You should always talk with a financial professional and tax advisor about your own unique situation before making any decisions. That said, we’ll cover some of the important and little-known details to understand as it relates to withdrawing funds from an IRA for the purpose of paying some or all of a retirement community’s entry fee, or for any other reason, for that matter.

>> Related: A Closer Look at CCRC Entry Fees

Withdrawals from IRAs and other tax-deferred accounts

A withdrawal from any type of IRA — except a Roth IRA — will be taxed as ordinary income. (The only exception would be if after-tax contributions had ever been made to the IRA.) The amount of ordinary income tax due on the withdrawal is based on your Adjusted Gross Income (AGI) in the year of withdrawal.

Here’s an example: Suppose you file jointly, and your adjusted gross income before the IRA withdrawal is $70,000. This would put you in the 12% tax bracket (as of tax year 2022-2023). Keep in mind that since we have a progressive tax system in the United States you would not pay 12% on all $70,000. Instead, you would pay 10% on the first $20,500 of AGI and 12% on the next $49,500 of AGI. Averaged out, this gives you an effective tax rate of approximately 11.5%.

Now, let’s suppose you were to withdraw $300,000 from an IRA to put towards the CCRC entry fee. Assuming there were no after-tax contributions previously made to the IRA, the entire withdrawal would be taxed as ordinary income and would bump you all the way up into the 35% tax bracket.

Again, in this example, you would not pay 35% on all $370,000 of AGI. According to the 2022-2023 ordinary income tax brackets, you would only pay the full 35% on everything above $215,950. Even still, your effective tax rate for the year of the withdrawal would be approximately 30% compared to 11.5%. (If you are under the age of 59½, there would be an additional 10% tax penalty on the withdrawal.)

It should be noted that withdrawals from other tax-deferred accounts, such as a tax-deferred annuity, may also be taxable as ordinary income. The exception with an annuity, however, is that only the gain is taxable. Contributions make up the cost basis and are not taxable upon withdrawal. However, the cost basis in an annuity cannot be accessed until all gains have first been distributed. Therefore, a $300,000 withdrawal from a tax-deferred annuity would be taxable to the extent that there is at least $300,000 of gain in the annuity. Note: If the annuity is held inside of an IRA, the same rules would apply as described previously.

Potential Medicare surcharges

Aside from the increased income tax burden associated with the withdrawal, there are other ways that a large withdrawal from an IRA could cost you more than expected. There is a Medicare surcharge, known as Income-Related Monthly Income Adjustment, or IRMAA, that can cause Medicare Part B premiums to more than triple for high-income earners. This could amount to hundreds of additional dollars in monthly surcharge payments.

For couples, the IRMAA increases begin at $194,000 of Modified Adjusted Gross Income (MAGI) in 2023 and cap out at $750,000. (For individuals, the range is $97,000 to $500,000.) In addition to the increase in Medicare Part B premiums, IRMAA also assesses an additional tax on the Medicare Part D prescription drug plan.

One interesting thing about this surcharge is that it looks back two tax years instead of just the most recent tax year. Therefore, a big withdrawal from an IRA in one year could mean significant Medicare premium increases two years later.

Withdrawals from non-IRA accounts

Now let’s look at what would happen if you withdrew the same $300,000 from a non-IRA account, such as a brokerage account holding stocks, bonds, mutual funds, etc. We’ll call this a “taxable account” because, unlike a tax-deferred account, in this type of account, taxes are due each year on interest, dividends, and capital gains generated in that tax-year.

If you were to withdraw the same $300,000 from the taxable account, it likely means some of the investment holdings within the account will need to be sold (unless it is already all in cash). If there is a gain on any of the investment holdings you sell, you may owe capital gains tax on the gain, instead of the ordinary income tax.

This is advantageous from a tax perspective because the capital gains tax brackets are lower than ordinary income tax brackets. Furthermore, the capital gains tax burden can be controlled somewhat because you can look to see which holdings have gains and which have losses. Any holdings you sell at a loss will help offset dollar-for-dollar the tax due on any capital gains.

Let’s assume the net capital gain on the $300,000 withdrawal is $200,000. Let’s also assume these are long-term capital gains and not short-term gains. (Short-term capital gains are taxed as ordinary income.) According to the 2023 capital gains tax tables, this would put you in the 15% capital gains tax bracket. You would owe 15% on the gain of $200,000, which amounts to $30,000. This represents only 10% of the entire withdrawal. When compared to the IRA withdrawal described above, you would save approximately $70,000 in federal taxes by taking the withdrawal from the taxable account in this example instead of from the IRA.

But what about the IRMAA Medicare surcharge? The withdrawal from the taxable account could still trigger the surcharge, but using the figures in our example, it would be at the lower end of the scale, so the cost impact would not be as high as it would be with the IRA withdrawal. This would likely save another few thousand dollars on the IRMAA surcharge compared to taking it from the IRA.

Net Investment Income Tax

There is yet another potential cost associated with the $300,000 withdrawal called the Net Investment Income Tax (NIIT), which applies to taxpayers with Modified Adjusted Gross Income (MAGI) of over $250,000. In our example, it would apply no matter whether it is taken from the IRA or the taxable account but would actually be larger for the withdrawal from the taxable account.

For those above the MAGI limit, the NIIT applies a surcharge of 3.8% on all investment-related income, including capital gains. Since the $300,000 withdrawal would likely put the taxpayer well above the $250,000 MAGI limit, there would be a 3.8% charge on top of the capital gains tax paid on the $150,000 capital gain. This is an additional $5,700. However, even with this NIIT surcharge, you would still come out far ahead in this example compared to the IRA withdrawal.

Informing you on options to pay the CCRC entry fee

Again, this blog post is not intended to be financial or tax advice as each person’s situation is different, but we hope it helps you understand some key considerations of taking a large withdrawal from an IRA or other types of accounts. In an upcoming post, we will delve into other possible ways to fund the entry fee and how the tax deduction available on some CCRC entry frees can help offset your tax burden.

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