How To Borrow Money From Your IRA
I manage individual retirement accounts (IRAs) for many clients throughout the country. Most of the IRAs I manage are traditional or rollover IRAs but I also manage SEP and Roth IRAs.
Every few months I get a request from a client that goes something like this: "Laurie, I'd like to borrow some money from my IRA...please help me do that." The answer is, "I can't." And that's because there is no such thing as an IRA loan.
Clients are often surprised at this answer. After all, when they had a 401(k) at work they were allowed to take a loan. There is a loophole, however, and that is you can withdraw money from your IRA without paying income tax or an early withdrawal penalty, as long as you PAY IT BACK WITHIN 60 DAYS. If you can't, you will get hit with federal and state income tax and if you are under 59 and a half, a 10% penalty as well. If you live in California you will also be assessed an additional 2.5% early withdrawal penalty!
I had a client who couldn't pay the money back within 60 days. At her tax rate, she ended up paying approximately 45% combined in tax and penalties.
Here's an example. Assume Mary has $100,000 in her Rollover IRA and needs to "borrow" $50,000. She sells some of her investments and withdraws the money. She can't pay back the money within 60 days so next year when she files her tax return, she needs to withdraw another $22,500 to cover the taxes and penalty. Her IRA was worth $100,000 and the following year it is worth only $27,500. And with the limits on how much one can contribute to an IRA each year, it is likely that it will take her years for that account to get back to $100,000.
So what can be done if you need money? There are exceptions for which the 10% penalty does not apply. And if you are in a low tax bracket the year you withdraw the funds, you may not have to pay that much in income tax. Some of the allowable exceptions include certain medical expenses, birth or adoption expenses, higher education expenses, health insurance if you are unemployed, or a down payment for a home if you are a first-time homebuyer, among others. You may be able to withdraw money without being assessed the 10% penalty although there are caps on the amount you can withdraw for certain situations.
Perhaps a better source of funds is a Roth IRA (if you have one). You can always withdraw the contributions you made without paying tax or a penalty (as you already paid taxes on this money). However, rules apply to whether you can also withdraw the earnings without paying tax and/or penalties. Schwab summarizes the rules here.
You may have read that there are exceptions to these rules if you have been negatively impacted by COVID-19. If you meet certain criteria you may be able to withdraw up to $100,000 from your IRA without having to pay the federal 10% early withdrawal penalty as long as you withdraw funds before December, 31, 2020. You also have the ability to return the funds (unlike in the previous case I mentioned) and prorate the income taxes over three years. The IRS has posted a Q&A on this topic.
DISCLAIMER: This article is for informational purposes and not intended as financial or investment advice. Before withdrawing money from your retirement account, consult with a financial advisor or tax professional who is familiar with your personal financial situation and is up-to-date on the relevant federal and state legislation and regulations and how they may impact you personally.
Laurie Itkin, CDFA, is a financial advisor, certified divorce financial analyst and author of the Amazon best-seller, Every Woman Should Know Her Options. She manages investment, trust and retirement accounts as a wealth manager at Coastwise Capital Group and has provided financial preparation, planning, and analysis to individuals and couples in more than 130 divorce cases throughout California. Subscribe to her monthly newsletter or contact her to schedule a brief phone consultation at firstname.lastname@example.org or 858-220-4736.