In today’s tough economic times, you may find yourself short on cash. The banks have tightened their lending policies and credit cards are not so easy to come by, but if you have an IRA, there is a way you can borrow funds from it when times get rough.
How to borrow money from your IRA
If you’re in need of some cash and you have a retirement account, there is a way for you to borrow from it for up to 60 days and pay no penalties or interest. Be advised that you can only do this once per year.
For example: Let’s say you want to borrow from your IRA on October 1, 2011. That means that the 60-day window begins that very next day and will end on November 30. No extensions are given for holidays or weekends. That means that if the due date falls on a Sunday, there is no forgiveness and no carryover, so be sure and deposit the loan back on that Friday before.
What if you have more than one IRA?
If you do indeed have more than one IRA, then the one-year rule of course does still apply to each one but they all will be treated separately. Let’s say you borrowed money from the first; as long as you redeposit that money back into the account within the 60-day period, then you’ve satisfied the requirements. But how would this affect IRA #2; can you still borrow from it within that same one-year period? The answer is yes. Each is treated separately and can be borrowed from once per year.
What happens if you don’t get the money back in 60 days?
They are serious when they say 60 days. Failure to put the money back within the 60-day window means that it will now be treated as a regular withdrawal and you will be taxed accordingly. There may also be state income taxes assessed and a 10% penalty. Be aware also that you will not be able to put the money back after the 60-day period, penalties or not.
For example, if you withdraw $10,000, assuming a 30% tax rate plus 10% penalty, that loan will cost you $4000 (or 40%). Likewise, if you are in financial distress and decide to file for bankruptcy, be advised that bankruptcy does not protect you from the IRS. There can be very severe ramifications involved with borrowing from your IRA, so do so very carefully.
Why the 60-day rule?
Now this is where it gets interesting. The 60-day rule was not set up originally so that you could take a loan against your IRA penalty free, but it’s really a loophole. The 60-day rule is actually in place to allow you to roll money over from one IRA account to another. The IRS allows you to do this, but in those 60 days you will have complete access to the money, thus the classification of a loan.
Why should you borrow from your IRA?
So why would you want to borrow from your IRA? The penalties and tax consequences if you do not repay the money are severe, so is it worth the risk? Sometimes, perhaps. Let’s say for example you find a home you want to buy. This residence is in foreclosure and at that price, well, it’s the deal of a lifetime. You have to grab it now, but if you go about getting traditional financing you’re never going to be able to snatch it up in time. So in this example, you could conceivably borrow the money from your IRA, buy the house, then turn around and get a mortgage. With the money from the mortgage you can then repay your IRA.
Of course, this still involves risk. You may want to ask yourself:
Are you 100% sure you will be getting that financing for the home? Make sure you can before you jump in.Even if you can get financing for the home, are you absolutely sure you can get it within the 60-day limit? Are there any other avenues? Any other way to get the money? Explore all other possibilities first.
In some cases, let’s say that home is valued at $400,000 and you can get it for half that, only $200,000, but you’re not sure you can get the financing completed within those 60 days. In this case, it might be better to go ahead and borrow the money from your IRA, depending on the amount needed, and take the penalties. Maybe the deal is just that good.
Things to watch out for
- Remember that you are going to be rolling over the cash, so make sure the IRA you are rolling it over into is already set up. Don’t wait until after you’ve borrowed the funds to start setting up your rollover IRA.
- Estimate your period for alternative funding and always leave yourself a little extra time to be sure it gets done.
- Be sure to explore all other avenues first. Example: You may be able to borrow on margin against your stock investments. This sounds highly technical, so be sure and ask your IRA administrator before you do anything. Find out what other options he may have for you.
- Remember that if your account is a Roth IRA, you can go ahead and withdraw money at any time without paying taxes or penalties. Be aware, however, that any money you do withdraw from this account cannot be replenished. Once you’ve withdrawn it, it’s gone for good.
You must be sure to report all IRA withdrawals by using line 15A on IRA form 1040. After redepositing the money tax free, then enter that taxable amount equal to zero on line 15B. Be sure to write the word Rollover next to line 15B. This properly notifies the IRS that you did borrow money and you did pay it back.
You may not have to borrow money from your IRA
Be aware that there are some exceptions made where you can withdraw money from your IRA, without penalties or interest, for emergencies. The IRS will allow you to withdraw money early, without consequences, for situations like medical emergencies, education costs, health insurance if you become unemployed, and a few other scenarios. Be aware that there are limits on how much you can withdraw and stipulations on how you can use it. For more on this please read my article IRA Withdrawal Rules on IRA.com.
Of course, this is not a loan (not a rollover) and the one pitfall here is that you will not be able to put the money back. In times of emergency however, it just may be necessary.