If you’re short on funds and have exhausted other options, you might consider borrowing money from your retirement plan. In some cases, this can be a cheaper alternative than using a credit card or taking out a personal loan. But if you’re not careful, it can cost you.
Many 401(k) accounts and other employer-sponsored retirement plans make it easy to borrow money and repay it over time, often with interest. However, with an individual retirement account (IRA), that’s not the case.
Still, some scenarios exist where you may “borrow” money from an IRA by withdrawing it and re-depositing it. In some cases, you can even withdraw from an IRA without penalties or interest. But before you begin, it’s essential to understand the risks and drawbacks, including potential IRS penalties.
No, you can not borrow money from an IRA, at least not in the traditional sense of taking out a loan. The IRS prohibits loans from a traditional or Roth IRA. Also, you may face penalties if you withdraw money from your IRA before age 59 ½ and don’t return it within 60 days. According to the IRS, early withdrawal usually triggers a 10% tax penalty, and the amount you withdraw is subject to federal taxes.
Important: If you don’t return money you withdraw from an IRA within 60 days, you could trigger a 10% penalty and be taxed on the amount withdrawn.
However, there are exceptions to the IRA early withdrawal penalty, allowing you to make early withdrawals from your IRA penalty-free. But you’ll likely have to pay income tax on the distribution.
Rollovers are used to move retirement savings from one account to another without penalty. For example, you may want to consolidate multiple IRAs or switch to a different IRA provider.
Once you withdraw money from your IRA, you have 60 days to deposit it into another qualifying retirement account and have it be considered a rollover for tax purposes. The IRS also lets you re-deposit the funds in the same IRA account within the 60-day window without penalty.
If you only require money for a very short period, making an IRA withdrawal and then returning it could be an option. But there are certain factors that could make this a very expensive option if you’re not prepared.
While using your IRA for a short-term loan can give you temporary access to funds, it’s not without risk. Weigh the pros and cons of borrowing from your IRA and consult with your financial adviser or tax accountant before making a decision.
When you contribute to a Roth IRA, the government has already taxed the money you deposit. For that reason, you can withdraw up to the amount of your Roth contributions tax- and penalty-free at any age.
The key word to remember here is “contribution.” You will face a 10% penalty and income tax on any earnings you withdraw before age 59 ½ from a Roth IRA, unless you qualify for one of the exemptions listed above.
Withdrawing money from a traditional IRA (non-Roth) should only be considered as a last resort. Most employer-sponsored retirement plans allow you to borrow money and give you more time to pay it back. But avoiding tapping your retirement funds altogether can make personal loans an even better option.
If your employer-sponsored 401(k) retirement plan allows you to borrow against your account, a 401(k) loan may make sense. You can borrow from your account without a penalty tax or income tax, and you don’t need good credit to be eligible.
The IRS allows you to borrow up to 50% of your vested balance with a cap of $50,000. The catch is you must repay the amount you withdraw plus interest within five years, or the withdrawal will count as a distribution, and you’ll be hit with a penalty and taxes. If you leave your job, you could have to repay your loan at a much sooner date, depending on your plan. If your plan doesn’t specify a repayment deadline, the IRS states you must repay your loan before your income taxes are due the following year.
Many experts recommend against borrowing from your retirement plan, as it reduces your retirement account’s growth potential. If you need money to consolidate debt or to get through a rough financial spot, a personal loan may be a better option. Shop and compare APRs for the best personal loans and see if the numbers make sense.
Related: Learn more about getting a personal loan on Credible.com