Using Roth IRA funds for first-time home purchase

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Topic Author
krylon80
Posts: 25
Joined: Wed Mar 28, 2012 11:52 am

Using Roth IRA funds for first-time home purchase

Post by krylon80 » Tue Mar 12, 2019 10:39 am

fellow bogleheads,

i'm purchasing my first home and i intend to use funds from my Roth IRA account.

according to the Roth IRA withdrawal rules (https://www.rothira.com/roth-ira-withdrawal-rules), the full amount of contributions can be withdrawn at any time tax and penalty free as long as the account has been open for 5 years, which mine has.

as for earnings, up to $10k can be withdrawn at any time tax and penalty free for the purpose of a first-time home purchase.

my question is, when making a withdrawal for the purpose of a first-time home purchase, how can i differentiate between withdrawing earnings vs withdrawing contributions?

for example, if i've made contributions of $20,000 and i've earned $5,000, and i wish to withdraw $5,000 for the purpose of a first-time home purchase, how can i designate that i am withdrawing $5,000 of EARNINGS and not $5,000 of CONTRIBUTIONS?

thanks!

260chrisb
Posts: 293
Joined: Wed Apr 28, 2010 7:26 pm

Re: Using Roth IRA funds for first-time home purchase

Post by 260chrisb » Tue Mar 12, 2019 10:44 am

This is an interesting question and I'm looking forward to an answer from folks much more informed than me but prepare yourself for the inevitable questions as to why you are using retirement funds for a home purchase. They are forthcoming.

BogleMelon
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Joined: Mon Feb 01, 2016 11:49 am

Re: Using Roth IRA funds for first-time home purchase

Post by BogleMelon » Tue Mar 12, 2019 10:56 am

krylon80 wrote:
Tue Mar 12, 2019 10:39 am
fellow bogleheads,

i'm purchasing my first home and i intend to use funds from my Roth IRA account.

according to the Roth IRA withdrawal rules (https://www.rothira.com/roth-ira-withdrawal-rules), the full amount of contributions can be withdrawn at any time tax and penalty free as long as the account has been open for 5 years, which mine has.

as for earnings, up to $10k can be withdrawn at any time tax and penalty free for the purpose of a first-time home purchase.

my question is, when making a withdrawal for the purpose of a first-time home purchase, how can i differentiate between withdrawing earnings vs withdrawing contributions?

for example, if i've made contributions of $20,000 and i've earned $5,000, and i wish to withdraw $5,000 for the purpose of a first-time home purchase, how can i designate that i am withdrawing $5,000 of EARNINGS and not $5,000 of CONTRIBUTIONS?

thanks!
Federally, it is FIFO (First in firt out method). You only need to keep track of your contributions to be sure you are not withdrawing from your earnings.
State wise, different from state to another. NJ is a pain in the neck (prorating the whole withdrawals), but probably still consider it qualified distribution for buying a first home.
"One of the funny things about stock market, every time one is buying another is selling, and both think they are astute" - William Feather

BogleMelon
Posts: 2073
Joined: Mon Feb 01, 2016 11:49 am

Re: Using Roth IRA funds for first-time home purchase

Post by BogleMelon » Tue Mar 12, 2019 10:57 am

260chrisb wrote:
Tue Mar 12, 2019 10:44 am
but prepare yourself for the inevitable questions as to why you are using retirement funds for a home purchase. They are forthcoming.
:D :D :D
"One of the funny things about stock market, every time one is buying another is selling, and both think they are astute" - William Feather

Topic Author
krylon80
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Joined: Wed Mar 28, 2012 11:52 am

Re: Using Roth IRA funds for first-time home purchase

Post by krylon80 » Tue Mar 12, 2019 11:16 am

BogleMelon wrote:
Tue Mar 12, 2019 10:56 am
Federally, it is FIFO (First in firt out method). You only need to keep track of your contributions to be sure you are not withdrawing from your earnings.
State wise, different from state to another. NJ is a pain in the neck (prorating the whole withdrawals), but probably still consider it qualified distribution for buying a first home.
Thanks BogleMelon,

Regarding the federal FIFO guidelines, if i made a contribution of $5,000 on Jan 1st, which earned $1,000, my withdrawal of $5,000 would be considered a withdrawal from my contributions, which would leave me with $0 in contributions and $1,000 in earnings, correct?

Alternatively, if i made an initial contribution of $2,500 on Jan 1st, which earned $500 by June 1st, followed by a subsequent contribution of $2,500 on June 2nd, then my withdrawal of $5,000 would be considered a withdrawal of $4,500 from contributions and $500 from earnings, which would leave me with $4,500 in contributions and $0 in earnings, correct?

Regarding the state guidelines i'm in MA. Do you happen to know the MA guidelines?

Thanks,

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Epsilon Delta
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Re: Using Roth IRA funds for first-time home purchase

Post by Epsilon Delta » Tue Mar 12, 2019 12:15 pm

krylon80 wrote:
Tue Mar 12, 2019 10:39 am
according to the Roth IRA withdrawal rules (https://www.rothira.com/roth-ira-withdrawal-rules), the full amount of contributions can be withdrawn at any time tax and penalty free as long as the account has been open for 5 years,
That article does not say that. Contributions are available tax and penalty free at any time, which is what it says.

Details matter here. If you are going to read something and conclude it says something it doesn't you are going to have problems.

I'd suggest you go to part III of form 8606 and the instructions, particularly for line 20. Reading them and filling out dummy tax returns with a #2 pencil is the best way to figure this out.

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Epsilon Delta
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Re: Using Roth IRA funds for first-time home purchase

Post by Epsilon Delta » Tue Mar 12, 2019 12:27 pm

krylon80 wrote:
Tue Mar 12, 2019 11:16 am
Regarding the federal FIFO guidelines

Alternatively, if i made an initial contribution of $2,500 on Jan 1st, which earned $500 by June 1st, followed by a subsequent contribution of $2,500 on June 2nd, then my withdrawal of $5,000 would be considered a withdrawal of $4,500 from contributions and $500 from earnings, which would leave me with $4,500 in contributions and $0 in earnings, correct?
Not correct. The $5000 would be a return of the two $2,500 contributions. It would be tax and penalty free and leave you with no contributions in the Roth.

The ordering rules are:
Contributions first.
Conversions next.
Finally earnings.

This is not a complete statement of the rules, but it is accurate as far as it goes and you can add the details as needed.

Topic Author
krylon80
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Re: Using Roth IRA funds for first-time home purchase

Post by krylon80 » Tue Mar 12, 2019 1:13 pm

Epsilon Delta wrote:
Tue Mar 12, 2019 12:27 pm
krylon80 wrote:
Tue Mar 12, 2019 11:16 am
Regarding the federal FIFO guidelines

Alternatively, if i made an initial contribution of $2,500 on Jan 1st, which earned $500 by June 1st, followed by a subsequent contribution of $2,500 on June 2nd, then my withdrawal of $5,000 would be considered a withdrawal of $4,500 from contributions and $500 from earnings, which would leave me with $4,500 in contributions and $0 in earnings, correct?
Not correct. The $5000 would be a return of the two $2,500 contributions. It would be tax and penalty free and leave you with no contributions in the Roth.

The ordering rules are:
Contributions first.
Conversions next.
Finally earnings.

This is not a complete statement of the rules, but it is accurate as far as it goes and you can add the details as needed.
OK, so if this is how it would be calculated, then a First-In, First-Out policy is not employed.

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corn18
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Re: Using Roth IRA funds for first-time home purchase

Post by corn18 » Tue Mar 12, 2019 1:17 pm

There is no FIFO for regular contributions. FIFO applies to conversions.

ORDER OF DISTRIBUTIONS

Regular contributions
Taxable portion of first conversion
Nontaxable portion of first conversion
Each subsequent conversion, in order, with the taxable portion coming out first for each conversion
Earnings (any increase in value occurring inside the Roth IRA)

TAXES AND PENALTIES

UNDER AGE 59.5 
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET 

Contributions: Tax-No; Penalty-No 
Conversions: Tax-No; Penalty-Yes (Taxable Portion) 
Conversions: Tax-No ;Penalty-No (Nontaxable Portion) 
Earnings: Tax-Yes; Penalty-Yes 

UNDER AGE 59.5 
FIVE YEAR CONVERSION HOLDING PERIOD MET 

Contributions: Tax-No; Penalty-No 
Conversions: Tax-No; Penalty-No (Taxable Portion) 
Conversions: Tax-No; Penalty-No (Nontaxable Portion) 
Earnings: Tax-Yes; Penalty-Yes 

OVER AGE 59.5 
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA 

Contributions: Tax-No ;Penalty-No 
Conversions: Tax-No; Penalty-No (Taxable Portion) 
Conversions: Tax-No; Penalty-No (Nontaxable Portion) 
Earnings: Tax-Yes; Penalty-No 

OVER AGE 59.5 
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA 

All Distributions Are Qualified 

No Taxes 
No Penalties 
Don't do something, just stand there!

nolesrule
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Re: Using Roth IRA funds for first-time home purchase

Post by nolesrule » Tue Mar 12, 2019 1:41 pm

corn18 wrote:
Tue Mar 12, 2019 1:17 pm
There is no FIFO for regular contributions. FIFO applies to conversions.

ORDER OF DISTRIBUTIONS

Regular contributions
Taxable portion of first conversion
Nontaxable portion of first conversion
Each subsequent conversion, in order, with the taxable portion coming out first for each conversion
Earnings (any increase in value occurring inside the Roth IRA)
Close. It's not FIFO of individual conversions but the sum of conversions within a calendar year. It makes a difference if you do multiple conversions in a calendar year.

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Epsilon Delta
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Re: Using Roth IRA funds for first-time home purchase

Post by Epsilon Delta » Tue Mar 12, 2019 1:46 pm

krylon80 wrote:
Tue Mar 12, 2019 1:13 pm
OK, so if this is how it would be calculated, then a First-In, First-Out policy is not employed.
That's probably a good take away.

But note that FIFO does come back as a secondary sort, particularly within the "conversion" category it can matter a lot.

Unfortunately the rules are complex and in general can't be simplified. However many situations do not need the full rules. But the only way to know if you've over simplified for your situation is to compare your result to the the full rules. That's what I'm trying to do here, I hope it's not too discouraging. :beer

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corn18
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Re: Using Roth IRA funds for first-time home purchase

Post by corn18 » Tue Mar 12, 2019 1:46 pm

nolesrule wrote:
Tue Mar 12, 2019 1:41 pm
corn18 wrote:
Tue Mar 12, 2019 1:17 pm
There is no FIFO for regular contributions. FIFO applies to conversions.

ORDER OF DISTRIBUTIONS

Regular contributions
Taxable portion of first conversion
Nontaxable portion of first conversion
Each subsequent conversion, in order, with the taxable portion coming out first for each conversion
Earnings (any increase in value occurring inside the Roth IRA)
Close. It's not FIFO of individual conversions but the sum of conversions within a calendar year. It makes a difference if you do multiple conversions in a calendar year.
Excellent catch!

I have only done backdoor and mega backdoor Roth conversions, but I keep careful accounting of everything so I can get the ordering correct. As of today, this is my withdrawal order. There are 8606's to go with all of this as well.

2015 BD Conversion Taxable 603.29
2015 BD Conversion Non Taxable 11,000.00
2016 BD Conversion Non Taxable 6,500.00
2016 MBD Conversion Taxable 71.08
2016 MBD Conversion Non-Taxable 15,011.62
2017 BD Conversion Taxable 22.98
2017 BD Conversion Non Taxable 6,500.00
2017 MBD Conversion Taxable 1,062.63
2017 MBD Conversion Non-Taxable 16,581.86
2018 BD Conversion Non Taxable 6,500.00
2018 MBD Conversion Non-Taxable 19,070.44
2019 BD Conversion Non Taxable 7,000.00
2019 MBD Conversion Taxable 2,000.00
2019 MBD Conversion Non Taxable 30,000.00
All Gains 4,282.06
Don't do something, just stand there!

Alan S.
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Location: Prescott, AZ

Re: Using Roth IRA funds for first-time home purchase

Post by Alan S. » Tue Mar 12, 2019 2:00 pm

krylon80 wrote:
Tue Mar 12, 2019 10:39 am
fellow bogleheads,

i'm purchasing my first home and i intend to use funds from my Roth IRA account.

according to the Roth IRA withdrawal rules (https://www.rothira.com/roth-ira-withdrawal-rules), the full amount of contributions can be withdrawn at any time tax and penalty free as long as the account has been open for 5 years, which mine has.

as for earnings, up to $10k can be withdrawn at any time tax and penalty free for the purpose of a first-time home purchase.

my question is, when making a withdrawal for the purpose of a first-time home purchase, how can i differentiate between withdrawing earnings vs withdrawing contributions?

for example, if i've made contributions of $20,000 and i've earned $5,000, and i wish to withdraw $5,000 for the purpose of a first-time home purchase, how can i designate that i am withdrawing $5,000 of EARNINGS and not $5,000 of CONTRIBUTIONS?

thanks!
Great question, but the explanation is anything but simple.

Using your example, since you only need 5000, just ignore the confusing first home feature. The ordering rules mean that you will receive 5000 from your Roth regular contribution basis, tax and penalty free. Your regular contribution basis going forward is reduced to 15000. This example is simple since you do not need more than basis.

On the other hand if you need to tap earnings, you do that by entering the amount you want to tap on line 20 of Form 8606 (10,000 lifetime limit). For the sake of illustration lets assume you want to tap your Roth earnings for that 5000, so you enter 5000 on line 20. Your regular Roth contribution basis remains 20000. The distribution is treated as qualified (essentially the qualified first home exception replaces the need to be 59.5 but you still need the 5 year holding).

Here is where things get tricky. Entering 5000 on line 20 will result in a tax free distribution, but don't do this if your main motivation is to keep your basis and reduce your earnings. It will not work going forward. The worksheets for line 22 in the 8606 Inst will result in your basis being reduced instead for future years. In other words, if you enter a figure on line 20 (5000), the worksheets are going to reduce your basis to 15000 in the following year, and since your Roth is now worth 20000, you still have 5000 of earnings in the Roth . Therefore your basis is reduced going forward, not your earnings. Accordingly, what you are getting by entering the first home expense on line 20 is a temporary tax free draw on your earnings. This is only useful if you have to tap earnings to get the amount you need.

So now lets assume instead you need to drain all 25000 from your Roth, so you list the 5000 (earnings) on line 20. In this case, since the worksheets will not reduce your basis below 0, after the tax free distribution you have a Roth with 0 balance and 0 basis. If you then make a new contribution in a later year that will restart your basis. In this situation, you got your 5000 of earnings out tax and penalty free without reducing future basis. Downside is you drained your Roth.

Same approach to conversion basis, if you have conversions.
First home is the most complex feature of Roth distributions, overly complex and overrated in many cases. However, for certain scenarios it can be beneficial.

Topic Author
krylon80
Posts: 25
Joined: Wed Mar 28, 2012 11:52 am

Re: Using Roth IRA funds for first-time home purchase

Post by krylon80 » Tue Mar 12, 2019 5:03 pm

Alan S. wrote:
Tue Mar 12, 2019 2:00 pm
krylon80 wrote:
Tue Mar 12, 2019 10:39 am
fellow bogleheads,

i'm purchasing my first home and i intend to use funds from my Roth IRA account.

according to the Roth IRA withdrawal rules (https://www.rothira.com/roth-ira-withdrawal-rules), the full amount of contributions can be withdrawn at any time tax and penalty free as long as the account has been open for 5 years, which mine has.

as for earnings, up to $10k can be withdrawn at any time tax and penalty free for the purpose of a first-time home purchase.

my question is, when making a withdrawal for the purpose of a first-time home purchase, how can i differentiate between withdrawing earnings vs withdrawing contributions?

for example, if i've made contributions of $20,000 and i've earned $5,000, and i wish to withdraw $5,000 for the purpose of a first-time home purchase, how can i designate that i am withdrawing $5,000 of EARNINGS and not $5,000 of CONTRIBUTIONS?

thanks!
Great question, but the explanation is anything but simple.

Using your example, since you only need 5000, just ignore the confusing first home feature. The ordering rules mean that you will receive 5000 from your Roth regular contribution basis, tax and penalty free. Your regular contribution basis going forward is reduced to 15000. This example is simple since you do not need more than basis.

On the other hand if you need to tap earnings, you do that by entering the amount you want to tap on line 20 of Form 8606 (10,000 lifetime limit). For the sake of illustration lets assume you want to tap your Roth earnings for that 5000, so you enter 5000 on line 20. Your regular Roth contribution basis remains 20000. The distribution is treated as qualified (essentially the qualified first home exception replaces the need to be 59.5 but you still need the 5 year holding).

Here is where things get tricky. Entering 5000 on line 20 will result in a tax free distribution, but don't do this if your main motivation is to keep your basis and reduce your earnings. It will not work going forward. The worksheets for line 22 in the 8606 Inst will result in your basis being reduced instead for future years. In other words, if you enter a figure on line 20 (5000), the worksheets are going to reduce your basis to 15000 in the following year, and since your Roth is now worth 20000, you still have 5000 of earnings in the Roth . Therefore your basis is reduced going forward, not your earnings. Accordingly, what you are getting by entering the first home expense on line 20 is a temporary tax free draw on your earnings. This is only useful if you have to tap earnings to get the amount you need.

So now lets assume instead you need to drain all 25000 from your Roth, so you list the 5000 (earnings) on line 20. In this case, since the worksheets will not reduce your basis below 0, after the tax free distribution you have a Roth with 0 balance and 0 basis. If you then make a new contribution in a later year that will restart your basis. In this situation, you got your 5000 of earnings out tax and penalty free without reducing future basis. Downside is you drained your Roth.

Same approach to conversion basis, if you have conversions.
First home is the most complex feature of Roth distributions, overly complex and overrated in many cases. However, for certain scenarios it can be beneficial.
thanks for the info!

Topic Author
krylon80
Posts: 25
Joined: Wed Mar 28, 2012 11:52 am

Re: Using Roth IRA funds for first-time home purchase

Post by krylon80 » Tue Mar 12, 2019 5:04 pm

thanks for all the help, everyone. i have a much better understanding on how Roth IRA distributions and exemptions work now.

that being said, all of this makes me want to go back to sticking money under the mattress, haha :?

Topic Author
krylon80
Posts: 25
Joined: Wed Mar 28, 2012 11:52 am

Re: Using Roth IRA funds for first-time home purchase

Post by krylon80 » Thu Mar 14, 2019 11:54 am

quick follow-up,

given that Roth IRA contributions can be distributed tax and penalty free at any time, how is it that brokerages are able to charge their own fee for a "premature distribution" of contributions (E*Trade's $25 premature distribution fee, for example)?

doesn't penalty free mean penalty free?

Alan S.
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Location: Prescott, AZ

Re: Using Roth IRA funds for first-time home purchase

Post by Alan S. » Thu Mar 14, 2019 12:04 pm

krylon80 wrote:
Thu Mar 14, 2019 11:54 am
quick follow-up,

given that Roth IRA contributions can be distributed tax and penalty free at any time, how is it that brokerages are able to charge their own fee for a "premature distribution" of contributions (E*Trade's $25 premature distribution fee, for example)?

doesn't penalty free mean penalty free?
Any custodian levied fee is unique to the custodian and outside of the IRS tax rules. In this and most all threads we are discussing the IRS rules that apply to all Roth or other retirement plan distributions and are not affected by any particular custodian. This E trade distribution fee is not typical and this is the first time that I have heard of it. More firms have proprietary fees for closing accounts, which also are not reflected in any 1099R, but your balance does drop when they take the fee directly out of your Roth. Also, note that certain investments have early redemption fees and these are also proprietary and have no relation to IRS tax rules. Just checked, and apparently E Trade also levies a $25 fee for the return of excess IRA contributions and for recharacterizations, as well as the more typical account closure fees or partial transfers to another custodian.

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Wiggums
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Re: Using Roth IRA funds for first-time home purchase

Post by Wiggums » Thu Mar 14, 2019 12:16 pm

Alan S. wrote:
Tue Mar 12, 2019 2:00 pm
krylon80 wrote:
Tue Mar 12, 2019 10:39 am
fellow bogleheads,

i'm purchasing my first home and i intend to use funds from my Roth IRA account.

according to the Roth IRA withdrawal rules (https://www.rothira.com/roth-ira-withdrawal-rules), the full amount of contributions can be withdrawn at any time tax and penalty free as long as the account has been open for 5 years, which mine has.

as for earnings, up to $10k can be withdrawn at any time tax and penalty free for the purpose of a first-time home purchase.

my question is, when making a withdrawal for the purpose of a first-time home purchase, how can i differentiate between withdrawing earnings vs withdrawing contributions?

for example, if i've made contributions of $20,000 and i've earned $5,000, and i wish to withdraw $5,000 for the purpose of a first-time home purchase, how can i designate that i am withdrawing $5,000 of EARNINGS and not $5,000 of CONTRIBUTIONS?

thanks!
Great question, but the explanation is anything but simple.

Using your example, since you only need 5000, just ignore the confusing first home feature. The ordering rules mean that you will receive 5000 from your Roth regular contribution basis, tax and penalty free. Your regular contribution basis going forward is reduced to 15000. This example is simple since you do not need more than basis.

On the other hand if you need to tap earnings, you do that by entering the amount you want to tap on line 20 of Form 8606 (10,000 lifetime limit). For the sake of illustration lets assume you want to tap your Roth earnings for that 5000, so you enter 5000 on line 20. Your regular Roth contribution basis remains 20000. The distribution is treated as qualified (essentially the qualified first home exception replaces the need to be 59.5 but you still need the 5 year holding).

Here is where things get tricky. Entering 5000 on line 20 will result in a tax free distribution, but don't do this if your main motivation is to keep your basis and reduce your earnings. It will not work going forward. The worksheets for line 22 in the 8606 Inst will result in your basis being reduced instead for future years. In other words, if you enter a figure on line 20 (5000), the worksheets are going to reduce your basis to 15000 in the following year, and since your Roth is now worth 20000, you still have 5000 of earnings in the Roth . Therefore your basis is reduced going forward, not your earnings. Accordingly, what you are getting by entering the first home expense on line 20 is a temporary tax free draw on your earnings. This is only useful if you have to tap earnings to get the amount you need.

So now lets assume instead you need to drain all 25000 from your Roth, so you list the 5000 (earnings) on line 20. In this case, since the worksheets will not reduce your basis below 0, after the tax free distribution you have a Roth with 0 balance and 0 basis. If you then make a new contribution in a later year that will restart your basis. In this situation, you got your 5000 of earnings out tax and penalty free without reducing future basis. Downside is you drained your Roth.

Same approach to conversion basis, if you have conversions.
First home is the most complex feature of Roth distributions, overly complex and overrated in many cases. However, for certain scenarios it can be beneficial.
Alan s — Thanks for the detailed response with examples. I learned a lot

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