Making a retirement plan when you’re young is very smart. However, unexpected things can happen, and sometimes, you may need money – where should you get it? On occasions, you could feel tempted to try and get a loan from your IRA.
IRS rules are complicated, and if you don’t want any financial trouble, you should understand what you’re dealing with if you try to get an early withdrawal from your account. In this article, you’ll learn what you must know about loans and IRAs.
Should You Borrow from Your IRA Money?
Honestly, you shouldn’t. When you open a traditional or Roth IRA, you’re committing to contributing money annually to work for your retirement.
The whole point of having a retirement account and getting tax benefits from it is that you’ll use it when you’re not able to work anymore or decide to retire. Therefore, trying to take funds before your time is due could bring you a lot of unwanted consequences, and it can affect what you can do in the future too.
Overall, the best advantage of having an IRA is that you can grow your wealth as long as you don’t take money out before the age of 59 and a half. Consequently, if you withdraw early, you’ll have to pay fees.
Some people believe that because they can withdraw early from their account, it means they’re taking out a loan, but it’s not the case.
There is no way to actually get a loan from your IRA funds. Instead, you can withdraw money, but there are numerous drawbacks to it, which is why you should try to avoid it as much as you can.
Options for Accessing IRA Funds
Even though you can’t get a loan with a Roth or traditional IRA, there are some ways to access your earnings if you need to. In other words, rules have exceptions, so if you desperately need to borrow money, you could take it from your own savings.
Short-term Rollovers
You may need a specific amount of money that you can pay a short while later. If this is the case, you could access your IRA funds with a rollover.
People often use rollovers when they need to transfer funds from a 401(k) to a new retirement account. If you do that, you could have all your earnings in one place.
In this case, you could do a rollover and take the money. However, you’ll have 60 days to put it back into another qualifying retirement account.
The IRS knows that people sometimes change their minds when moving money between retirement accounts. Therefore, you can either put the earnings in a new IRA or deposit them in the previous one. You’re allowed to do both things.
Doing an indirect rollover means you could potentially use the money for 60 days before having to put it back, with no penalties. However, there are some significant drawbacks and risks, so take a look:
20% Interest: You don’t usually pay interest when it comes to rollover funds. However, tax law requires administrators to keep 20% of the rollovers to pay taxes in case you don’t complete them. Once you deposit the money into your IRA, you’ll have to put in the whole amount you took, even what you never got. In other words, if you withdraw $10,000, you’ll get $8,000, and you’ll have to put back $10,000.
One-year Limit: You can only do this once every 12 months, so it’s not the best option if you need to borrow money from time to time.
Fees: Administrators may charge for rollovers.
Taxes and Penalties: You won’t have to pay income taxes if you put the money back within the mandatory 60 days. However, if you fail to do so, the IRS will treat it as an IRA distribution, and if you’re not 59 and a half, you’ll have to pay early withdrawal fees.
Withdrawals for Specific Needs
Generally, you’ll have to pay a 10% early withdrawal fee if you’re not 59 and a half and need to take some money out of your IRA funds. However, there are some exceptions to the rule as well.
In some cases, you may have to pay ordinary income tax but not the fee. The following examples are exceptions to the 10% rule:
Qualified higher-education expenses.
Significant medical expenses, which depend on the case.
Health insurance premiums while the person is not working.
Permanent and total disability of the IRA owner.
Up to $10,000 for first-home buyers.
Unreimbursed medical expenses making up more than 7.5% of your adjusted gross income.
Roth IRA Withdrawals
If you want to withdraw funds from your account, you need to keep in mind that a Roth IRA works differently than a traditional one.
When you deposit money into your Roth IRA, you make after-taxes contributions. Therefore, if you’re able to wait until you’re of retirement age and meet certain requirements, you can withdraw IRA funds without penalties or having to pay taxes.
However, not everyone meets the requirements – for example, you need to have your Roth IRA account open for five years before taking money out.
In some cases, people need to access their money before the age of 59 and a half, and when you have a Roth IRA, you could do it without paying taxes or fees.
Plus, if you withdraw funds from your Roth IRA before the tax-filing deadline of the same contribution year, they won’t count for that year’s cap.
However, you have to be careful when you need IRA money. If you do things the wrong way, you will have to pay a 10% penalty unless you’re buying or building a first home, paying for health expenses, premiums, or higher education, or if you have a disability.
Some Drawbacks
As you can see, there is no specific way to get an IRA loan. However, it doesn’t mean you can’t access your funds.
You can’t borrow from your IRA, but you can get some of your money if you really need it. Even so, you shouldn’t do it unless you have no other options because the risks are too high. Here are two top reasons why you shouldn’t raid your account:
You may have to deal with complicated consequences: If you try to borrow from an IRA using the rollover technique and don’t put your money back, you may have to pay a lot more. Plus, it could also happen if your case is not an exception or if you accidentally withdraw earnings instead of contributions.
Losing potential growth: One of the best parts of having an individual retirement account is that your wealth will grow over time. However, this can’t happen if you withdraw it. If you have a Roth IRA, withdraw money counting for your annual cap, or use your traditional IRA, you won’t be able to put the earnings back, so you’ll lose the chance of building it up for your retirement.
What About Income Taxes?
Traditional and Roth IRAs often provide advantages when it comes to your income taxes, but this is as long as you deposit your money and leave it there.
If you don’t want to pay income taxes, you should avoid early withdrawals and overall try to regularly contribute to your account and keep your documents up to date.
When Should You Borrow from an IRA?
You can’t actually get an IRA loan, so if you withdraw funds without preventing any possible issues, you’ll most likely have to pay fees and penalties for having taken your money early.
Since there are so many risks when you borrow from your IRA, advisors usually don’t recommend it. However, there are some exceptions as well, and if you’re in an emergency or don’t have anywhere else to turn to, you might think the risk is worth it.
What Happens If You Don't Pay Back the Loan?
When you use the rollover method, you could technically access money for 60 days. Nonetheless, there are severe consequences if you don’t put it back.
The IRS will treat the transaction as though it was a taxable distribution. Therefore, you’ll have to pay taxes and penalties.
Plus, suppose that you use the IRA ‘loan’ to help you manage a tough financial time. If you go bankrupt during the 60-day period, you’ll still owe the IRS tax and penalties that apply to the amount you withdrew.
Process for Taking Money from Your IRA
As the article mentioned, there are some direct ways to access your retirement savings if your specific case falls into one of the exception categories.
If you’re buying or building a home for the first time, for instance, you’re able to access money from your traditional IRA without having so much trouble.
Even though you still have to go through a process, there won’t be so much stress as when trying to get IRA loans, primarily because these don’t exist. Here are the stages of the procedure:
Check If You’re Financially Eligible
Firstly, you’ll have to see if the property you chose is financially eligible. If it is, you have to complete the loan application and provide recent bank statements. You’ll also need to include your spouse, when applicable.
Review the Documents
Your IRA custodian will help you review the documents. Then, you’ll have to complete and sign them.
Get the Funds
Your custodian will help you get your funds directly from your retirement savings to your bank account for appraisals and fees.
In addition, you should get a minimum policy term of one year when it comes to IRA loans. At least two weeks before you close the deal, make sure to provide the bank with policy and invoice copies.
Receive the Approved Documents
Once the bank verifies your documents, reviews your application, orders the appraisal, and confirms the closing dates, it’ll notify you if it approves your loan.
After you get the approval, your IRA custodian will execute your real estate documents and transfer the funds directly from your retirement savings to the property company.
Frequently Asked Questions
Can I Take a Loan from My IRA?
Technically, no, you can’t get IRA loans. However, there is a method to access some of your funds if you desperately need them, but you have to put them back within 60 days if you don’t want to suffer the consequences of it.
In some cases, you could also access your retirement savings, for example, if you have to deal with unexpected and significant medical expenses, including paying for higher education or buying a property for the first time.
How Long Can You Borrow from an IRA?
You can’t borrow from an individual retirement account. Therefore, there is no specific time. However, if you use the rollover method to take out some funds, you’ll have to put them back in the same IRA in 60 days.
If you go bankrupt during that time, you’ll still owe the IRS and will probably have to pay fees and penalties for having missed the deadline.
Are There Consequences If You Borrow Against an IRA?
There could be consequences if you withdraw from your retirement funds before you’re able to. Therefore, you need to explore all your options and never take unnecessary risks. If you need help, talk to a financial advisor.
Final Thoughts
Your retirement plan can work even if you encounter some challenges. Nonetheless, you need to be aware of the IRS rules and regulations, and make sure you follow them so that you don’t have to deal with unexpected and complicated consequences.
Instead of withdrawing money from your retirement savings, try to explore all your options first. If you don’t have any other alternatives, talk things out with a financial advisor and see what they think.
Sometimes, when you’re in a tough financial spot, you may not be aware of all the alternatives you have. Therefore, make sure you’re making the best choice given your circumstances and considering your plans for the future.
About Tim Schmidt
Tim Schmidt is an Entrepreneur who has covered retirement investing since 2012. He started this website to share his expertise in using his Self-Directed IRA. Most recently he's been advising individuals to diversify into precious metals ahead of a certain recession. He invested with Goldco.