How to Borrow From an IRA

How to Borrow From an IRA

Type-based borrowing

Q: Can you borrow from an IRA?

While you can’t borrow from an IRA in the traditional sense, there is a way to remove money from an IRA and then replace it within a specified period of time without incurring a penalty.

Under the 60-day rule, an IRA account owner may take money out as long as it is returned in full within a 60-day period, beginning from the original withdrawal date (more on that below). While this isn’t technically borrowing in a principal-plus-interest sense, it serves a similar function — with caveats.

Q: Can you borrow against a Roth IRA?

Not really. Like a traditional IRA, a Roth IRA is meant for long-term saving and investing and is specifically intended to fund retirement expenses. But there are ways to circumvent this intent. You’re permitted to withdraw Roth IRA contributions at any time, regardless of your age, so there is a way to access some Roth money early. 

Q: Can you borrow from an inherited IRA?

No. An inherited IRA is the one IRA type that doesn’t allow contributions or 60-day rule transactions. Once the money’s out, it’s out. The IRS wants you to liquidate these accounts as soon as possible. This way, you will pay income tax sooner, but you also have access to the funds sooner. With the recent elimination of the stretch IRA under the new inherited IRA rules, in most cases you’ll now need to liquidate these accounts within 10 years of inheriting one if you’re a non-spouse beneficiary. 

Q: Can you borrow against a SEP IRA?

Again, not really, but you are able to remove money and then replace it within 60 days. The IRS makes it difficult to do this because a SEP IRA, much like the other IRAs on this list, is intended to help cover your retirement expenses, not fund short-term goals. If you do choose to remove money, you’ll need to ensure all of it is paid back within a 60-day period to avoid taxes and penalties.

Q: Can you borrow against a traditional IRA?

Not in the true sense, but there are many ways to access IRA funds in the event of an emergency (if you were to become disabled) or a milestone life event (purchasing a home for the first time or having a child). The amounts tend to be on the smaller end, so tapping your retirement to fund these expenses is generally not recommended as a first option.

Image source: Getty Images.

Image source: Getty Images.

Investing in a Business

If you want to use assets in your IRA to invest in a business, you might be able to pull it off, but it's not easy.

Instead of borrowing from your IRA, you can establish an entity, fund it with the savings in your IRA, and use that entity to buy an interest in the business. The process typically involves setting up what is called a “self-directed IRA,” which is used to invest in real estate. The IRS has strict rules about the types of investments that are allowable, and it is important to consult with a financial adviser before pursuing that option.

You'll need to work with a firm that specializes in using IRAs to invest in businesses or real estate. If you go that route, expect to pay fees to get set up. You'll have to pay annual fees as well.

If you use your IRA to invest in a business, you risk losing your income ​as well as your nest egg. As an alternative, you might be eligible for business loans backed by the U.S. Small Business Administration (SBA). Government backing makes it easier to qualify for loans and keeps borrowing costs low.

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Taxes and Fees

Rollovers and transfers of qualified funds are non-taxable events and are not subject to IRS penalties. However, the rollover becomes taxable if the funds are not placed back into the same account or another qualified account within 60 days.

If the rollover amount does not equal the amount of the original distribution, the difference is taxable as income and may be subject to an early withdrawal penalty. For example, a 57-year-old IRA account holder withdraws $5,000 but only rolls over $4,000 into an IRA within 60 days. The difference of $1,000 is taxable and subject to a 10% IRS penalty.

Withdrawals may also be subject to charges or penalty fees from the custodian. For example, annuities are retirement accounts that often have withdrawal charge schedules that typically range from 7 to 10 years. Charges typically decrease annually.

Consider an IRA annuity owner withdrawing funds in the first contract year. They will likely have a higher charge than an account holder withdrawing funds in their tenth contract year. Someone withdrawing funds outside of the withdrawal charge schedule will not incur charges.

Also, some custodians charge a flat fee for all withdrawals regardless of how long you've had the account. It's important to understand the rules and provisions of the IRA account before requesting withdrawals, even if the money is repaid within the rollover timeframe.

Penalty Exceptions

There are exceptions to the 10% penalty on withdrawals before age 59.5. If you need money because you have become totally and permanently disabled, you won’t face the 10% ding. Ditto if you need to pay for qualified higher education expenses.

If you’re a qualified first-time homebuyer, you can withdraw up to $10,000 without penalty. Also, if you have unreimbursed medical expenses, you may be able to withdraw penalty-free an amount equal to whatever is in excess of 10% of your adjusted gross income.

What Are the Early Withdrawal Penalties on a 401(K) And an IRA?

The early withdrawal penalty is a 10% tax on the amount withdrawn, plus you will be required to pay additional state and federal taxes on the withdrawn funds.

Is it better to borrow from an IRA or a 401(k)?

If you really want to borrow your retirement funds rather than withdrawing them and replacing them later on, you can do that with a 401(k) if you have one. There are strict rules as to how much you can borrow and when it needs to be repaid. Check with your 401(k) administrator for details.

What are the Qualification Criteria for an Ira to Borrow Money?

Certain lenders offer non-recourse IRA loans for the purchase of rental property, where property itself acts as security, instead of the account holder or IRA.

To qualify for an IRA non-recourse loan:

  • The real estate investment must make financial sense – meaning positives cash flow
  • You should have 15% of the loan amount as a ready reserve
  • Most non-recourse lenders will lend up up 60 – 65% LTV (loan to value).

Therefor you must have 30%-40% of the property’s purchase price in a self-directed IRA, to cover down payment and fees

Loans Prohibited

Internal Revenue Service code specifically prohibits you from borrowing money from an IRA account. This includes using the account as collateral for a loan. If you borrow from your IRA, any amount that you borrow is treated as a distribution, or withdrawal. If you use your account as collateral for a loan, the entire balance of the account is considered distributed. These distributions are subject to any taxes and penalties that may apply for early distributions.

Here are a few ways you can borrow from your IRA without attracting a penalty:

  • If you’re 59½ or above, you can request a distribution from your traditional IRA without any penalty. However, since your original contributions were tax-deductible, you’ll need to pay income tax on the money you pull out.

  • However, if you own a Roth IRA, you can withdraw both contributions and earnings tax-free and penalty-free – if you are 59½ or above and have owned your Roth IRA for five years or more. With a Roth IRA, you can pull out the money from the account any time you want without any tax or penalty. However, you’ll have to withdraw only the contributions and not the investment earnings (such as interest you have earned on the contributions or dividends). If you withdraw the earnings early, you’ll have to pay a 10% penalty and also income tax on the amount you withdrew.

  • If you can repay the borrowed money in 60 days or less, you can use the 60-day rollover rule to your advantage. The IRS allows you to roll money from one IRA to another or pull money out from your IRA as long as you put it back in the same IRA within 60 days. Follow this IRA 60-day rollover rule, and you will not have to pay taxes and penalties.

2. Can I roll over the outstanding loan balance from my retirement plan into an IRA?

IRAs (including SEP-IRAs) do not permit loans. If this transaction was attempted, the the IRA could be disqualified.

 

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Using IRA Funds is a Distribution

What are your options if you need to tap into your IRA funds and use them for personal purposes, such as paying off a credit card bill, student loan, or even a mortgage payment?

Unfortunately, when an IRA holder takes money out of his or her IRA for personal use, this is referred to as a “distribution.” Taking a distribution from your IRA could have significant tax ramifications, including no longer benefiting from the power of tax-deferral. In addition, the future value of the remaining IRA will be impacted.

How much can you borrow from an IRA?

If you transfer your IRA money to a Beagle account, you can borrow up to half of your retirement savings, up to a maximum of $50,000. For example, if your account balance is $80,000, you can borrow up to $40,000.

You will be required to pay the loan over a five-year period in equal installments. However, if you get a large payment during the repayment period, you can pay a lump sum amount to clear the outstanding balance without owing a prepayment penalty.

Key takeaways

Borrowing from your IRA is possible, but it is not recommended. There are also ways to qualify for an early distribution for qualified expenses such as buying a home, but these IRA distributions fall under an exception and do not need to be returned to your IRA. Keep in mind they call it an individual retirement account for a reason. Your IRA is meant for retirement, and it’s much preferred to use it for its intended purpose.

401(k) Loan

This is probably the easiest way to access retirement money early for many workers. Some plans allow you to borrow from your 401(k) for various reasons.

With a 401(k) loan, you can withdraw the lesser of $50,000 or half the vested balance in your account. You then repay your account over a period of up to five years.

Some employers allow a longer period if you borrow to buy a home. Some plans allow the borrower to reimburse the account early with no pre-payment penalty. It’s worth noting that you typically pay back a little more than you took out of the account. This “interest” actually works to the borrower’s advantage. Because the funds go into your account, you’re essentially making up for some of the interest or capital gains the money would have accrued had you not withdrawn it from the fund. These loans are quick and easy to access, don’t hurt your credit rating (assuming you pay the loan back), have repayment flexibility, and are affordable with no to low origination fees.

Some downsides? Most 401(k) plan providers and platforms will charge fees to process and service a loan, which adds to the cost of borrowing and repayment. Also, not all employers offer these loans. Your odds of getting one are better if you work for a large company.

You may also withdraw up to $5,000 without penalty to deal with a birth or adoption under the terms of the SECURE Act of 2019.

How Much Can You Borrow From An IRA Without Penalty?

IRAs do not allow for loans. However, funds withdrawn and repaid into the IRA account within 60 days avoid the IRS penalty. Note that the IRS allows only one rollover every 12 months.

The Roth Conversion

A Roth IRA is funded with after-tax dollars, so there aren’t any penalties or tax liabilities for withdrawals. You could convert your traditional IRA into a Roth IRA and then just withdraw the money you need.

The catch here is that you’ll have to pay income taxes on IRA funds that you convert to a Roth account. Also, you’ll have to wait five years after establishing the Roth before you can withdraw earnings from it tax-free. You can still withdraw the original amount you contributed, plus any additional contributions.

You can make withdrawals to meet specific needs

In a handful of instances, you might not owe an additional 10% federal tax when you withdraw assets from a traditional or Roth IRA before age 59½. Eligible withdrawals include money used:
  • For a qualified first-time homebuyer distribution (up to $10,000; in line with federal tax laws)
  • For qualified higher education expenses (in line with federal tax laws)
  • If you become permanently disabled (in line with federal tax laws)
  • For the birth or adoption of a child (up to $5,000; in line with federal tax laws)

60-Day Rollover

If your need for money is short-term, you can take advantage of the tax-free rollover provisions in the IRA laws. You can withdraw money from your IRA account, and not pay any taxes or penalties on the money you as long as the money is put back into the same IRA, or another IRA of the same type, within 60 days. You can use that money for any purpose during that time period.

10.  What are the differences in the loan rules for amounts borrowed by participants after Hurricanes Harvey, Irma and Maria?

For participants affected by Hurricanes Harvey, Irma, or Maria, the maximum amount that can be borrowed from August 23, 2017 (affected by Harvey), September 4, 2017 (affected by Irma), or September 16, 2017 (affected by Maria), through December 31, 2018, from a plan is generally increased to the lesser of $100,000 or 100% of the participant’s account balance. In addition, repayments due from affected individuals may be suspended by the plan for one year.

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