If you are wondering about getting an IRA loan, it’s important to know that it’s not possible to take a loan from an IRA or Roth IRA. Making an early withdrawal from an IRA is an option, but that can come with taxes and penalties. You can borrow money from a 401(k) plan, however, without any penalties.
Read on to learn the impact of an early withdrawal from an IRA and some other ways to find the cash for unexpected expenses.
Key Points
• IRA loans do not exist; funds can only be withdrawn from accounts.
• Withdrawals from traditional IRAs before age 59 1/2 incur taxes and penalties.
• Roth IRA contributions can be withdrawn tax-free and penalty-free after five years.
• A 60-day rollover rule allows temporary access to IRA funds without penalties, provided the money is repaid to the IRA or another qualifying retirement account.
• Alternatives to early IRA withdrawals include family loans, credit card advances, and personal loans.
Understanding IRA Loans
Here, take a closer look at what the concept of an IRA loan actually involves.
What Is an IRA Loan?
First, a quick review of what an individual retirement account (IRA) is. It’s a savings account with tax advantages that is designed as a long-term investment vehicle for your retirement. The money that people invest in IRAs goes to a wide range of financial products, including stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Banks and investment companies rely on holding the funds for a long time, so lawmakers created strict rules around withdrawing money from traditional and Roth IRAs. There is usually a 10% penalty and an income tax bill.
IRA loans and Roth IRA loans are not allowed. You cannot borrow money from these accounts, but you can withdraw cash from your IRA if you have to, at a cost. When people use the expression “IRA loan,” what they may actually mean is an early IRA withdrawal.
Pros and Cons of Taking Out an IRA Loan
Here are the benefits and downsides of early withdrawal from your individual retirement account.
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Pros:
• Access to funds when you need cash
• Possibility of avoiding any early withdrawal penalties depending on how funds are used
• Withdrawing cash may help you pay off high-interest debt
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Cons:
• Withdrawing funds, plus paying taxes and possibly penalties, could take a chunk out of your retirement savings
• By lowering the amount in your IRA, may lose out on future growth
• May not meet your goals for retirement in terms of how much you have saved and what lifestyle you’ll enjoy
How Does an IRA Loan Work?
As noted above, you can’t take a typical loan from your IRA. The closest option is to try a work-around. The Internal Revenue Service (IRS) allows tax-free rollovers from an IRA if the funds are deposited back into the IRA or a different retirement plan or IRA within 60 days. If the funds are not rolled over in this way, you will have to pay taxes and a penalty. This 60-day rule can give you access to your IRA funds for a window of time.
Otherwise, an IRA loan amounts to an IRA withdrawal that, depending on such factors as its purpose and your age, may trigger taxes and fees.
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IRA Loan Eligibility
Here’s what you can and can’t do regarding withdrawing cash from traditional and Roth IRAs.
Who Is Eligible for an IRA Loan?
Here’s a closer look at the guidelines for accessing IRA funds depending on the specific type of account you hold.
Traditional IRAs: If you are 59 ½ or older, you can take money out of your traditional IRA with no penalty, but you’ll owe income taxes on the money you pull out.
Account holders of any age can withdraw funds from an IRA and roll them over into another IRA or redeposit them into the same IRA within 60 days, as noted above. This amounts to a 60-day loan, and you can do this once every 12 months. If you don’t roll over the funds within 60 days, the action will be considered a withdrawal or lump-sum cash distribution. That means paying federal and state taxes plus an additional 10% federal tax fee.
There are some exceptions that will allow you to avoid the additional 10% federal tax:
• First-time homebuyers can withdraw $10,000 for a down payment.
• The funds are used for higher education expenses.
• The funds are used for the birth or adoption of a child.
• You have become permanently disabled.
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Roth IRAs: If you’re at least 59 ½ and you’ve owned your Roth IRA for five years or more, you can take tax- and penalty-free Roth withdrawals of contributions. However, if you withdraw earnings, such as dividends or interest, you might have to pay the 10% penalty and income and state tax on that portion of the withdrawal.
What are the requirements to qualify for an IRA loan?
As noted above, you can access funds from your IRA if needed, even before retirement age. However, there are several factors that can determine the impact of early withdrawal from an IRA:
• What type of IRA you have
• What your age is at the time of withdrawal
• What purpose you use the withdrawal for
• Whether you return the funds to a qualifying retirement plan
By understanding where you stand in terms of these considerations, you will know what kind of taxes and fees you may have to pay for accessing IRA funds.
Are there any restrictions or limitations on IRA loans?
There can be restrictions and limitations on IRA withdrawals or loans, if you want to call them that. Among them:
• The age at which you access funds. If you have not yet turned 59 ½, the withdrawal will be considered early and involve additional penalties.
• The purpose can impact how much you pay in taxes and fees. If you are applying the withdrawal to the down payment on a first home or for higher education expenses, you may not be assessed the additional 10% early withdrawal penalty if you are younger than age 59 ½.
IRA Loan vs. Other Options
There are alternatives to withdrawing funds from an IRA. The best option for you depends on how much cash you need, the taxes and penalties you might pay, and the interest and fees you might pay on the alternative. Here’s a look at some of them.
IRA Loan vs. Other Options
Now that you know how IRA loans work, consider these alternatives:
• Family Loan: A family loan could be the best option if you can negotiate favorable terms. This route is also the most flexible but can affect family relationships if not handled well. Be sure to set expectations and draw up a contract to protect both parties. While some people may be lucky enough to score a no-interest loan, most can expect to pay for this privilege of access to cash. However, you can likely avoid closing costs and the like. And, of course, you are dodging the taxes and possible penalties involved when withdrawing from an IRA.
• Credit Card Cash Advance: A credit card cash advance is a quick way to get funds by borrowing against the credit limit on your credit card. No hard credit inquiry is needed, so there is no effect on your credit score. You can pay small fixed monthly payments, but there will be interest that accrues daily as well as fees.
◦ However, the potentially high interest charges (often higher than the standard credit card interest rate) and fees will need to be weighed against the cost of an early withdrawal from an IRA. There may be an additional charge of up to 5% for a cash withdrawal. There may also be a flat charge for a withdrawal in addition to the percentage charge. Depending on your credit line, the amount you can withdraw may be less than your credit limit.
• Personal Loan: If you are looking for a specific sum of money that you would like to repay over time, a personal loan could be a good choice. These usually unsecured loans can be used for almost any purpose (from affording IVF to paying for home renovation) and are often funded quickly.
◦ Current personal loan interest rates are generally much lower than for a cash advance on your credit and could offer you a better deal than paying taxes and possibly penalties on an IRA withdrawal. Also, you will not be cutting into your nest egg and lessening its opportunities for growth.
How Does an IRA Loan Differ From a 401(k) Loan?
Borrowing from your 401(k) is allowed. If your plan is amenable, you can take out as much as 50% of your savings, up to a maximum of $50,000, within 12 months. You will have to pay back the money, plus interest, within five years. However, the interest is paid back into your own account.
The advantage of a 401(k) loan is that there are no taxes or penalties. The disadvantage is that if you leave your current job, you may have to repay your loan in full. If you cannot, you’ll likely owe both taxes and a 10% penalty if you’re under 59 ½.
Benefits of Choosing an IRA Loan Over Other Financing Methods
Deciding whether to make an IRA withdrawal vs. other financing methods can require careful consideration and a bit of math. Overall, the pros of early IRA withdrawal, or an IRA loan, are:
• If you have a Roth IRA, you can withdraw contributions (but not earnings) free of tax and penalties.
• Early withdrawals provide emergency funds without interest and fees.
Benefits and Risks of IRA Loans
Here’s a snapshot of the pros and cons of IRA loans.
Advantages of Using an IRA Loan for Financing
As noted above, by tapping your IRA funds, you can access cash without paying interest or loan-related fees. Also, if you have a Roth IRA, your contributions are available tax- and penalty-free.
Potential Risks and Considerations of IRA Loans
While dipping into your IRA may seem like a good way to get fast cash in hand, consider the downsides carefully before doing so:
• You will likely owe taxes and possibly early withdrawal penalties.
• Unless you follow the 60-day rule, you cannot repay the money you withdraw, so you will have less of a nest egg for retirement.
• If you withdraw gains from a Roth IRA, you may have to pay taxes and fees.
• You miss out on earnings from the amount that you withdraw.
Factors to Consider Before Deciding on an IRA Loan
Before you make a withdrawal from your IRA, think through the following:
• If you are hoping to put funds back before the 60-day cutoff, how will you make that payment?
• Are you prepared to pay taxes and any penalties?
• Are you comfortable reducing your nest egg and its ability to grow over time?
IRA Loan Repayment and Consequences
Lastly, strategize how you might repay an IRA loan, if that’s your plan.
How to Repay an IRA Loan
If you are taking a loan from your IRA under the 60-day rule, that is exactly how long you have to put the funds back into a qualifying account. You must repay the funds within 60 days of distribution either into the account it came out of or another acceptable retirement vehicle.
Consequences of Defaulting on an IRA Loan
If you do not repay your IRA loan or roll it into another qualifying account within the 60-day window, the funds withdrawn become taxable. In addition, you may be subject to penalty charges as well.
Impact of an IRA Loan on Retirement Savings
As noted above, an IRA withdrawal can incur taxes and penalties. In addition, it’s wise to think over the impact of an IRA loan on your retirement savings in a big-picture way.
• You will be reducing the amount of money you have in your account to use during retirement.
• Less money in your account means you are also decreasing the ability of that sum to generate returns.
This two-fold hit to your savings can shift your retirement savings plans, so consider this carefully, perhaps meeting with a financial advisor to gain more perspective.
The Takeaway
Typically, account holders may not take out loans from an IRA or Roth IRA. Making a withdrawal from an IRA is an option, but that likely comes with taxes and possibly a 10% early-withdrawal penalty. You may be able to take advantage of the 60-day rule, though, and repay the funds or roll them into another qualifying retirement vehicle. Alternatives to early IRA withdrawal include credit cards, borrowing from family, and a personal loan.
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FAQ
Can I take a loan from my IRA?
There is no such thing as an IRA loan because you cannot pay the money back. You can withdraw funds from an IRA and roll them over into the same or another IRA within 60 days, and you can do this once every 12 months. If you don’t roll over the funds within 60 days, the action will be considered a withdrawal or lump-sum cash distribution. That means you will have to pay federal and state taxes plus possibly an additional 10% penalty.
How do I get an IRA loan?
You can’t borrow from your IRA. However, if you’re 59 ½ or older, you can request a distribution from your traditional IRA without any penalty. Since your original contributions were tax-deductible, you’ll need to pay income tax on the funds you withdraw.
If you have a Roth IRA, you can withdraw both contributions and earnings tax-free and penalty-free, but only if you are 59 ½ or older and have owned your Roth IRA for five years or more. If you withdraw earnings early, you’ll have to pay a 10% penalty and income tax on the amount you withdraw.
Lastly, you can use the 60-day rollover rule to your advantage if you can repay the borrowed money in 60 days or less and avoid paying taxes and penalties.
What is a 401(k) loan?
For a 401(k) loan, you can borrow money from your retirement account. Details can vary, but you might be able to take out up to 50% of your vested funds or $50,000 (whichever sum is less). If 50% of your vested balance is less than $10,000 you may be able to borrow up to $10,000. You will usually have to pay that back with interest within five years.
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