In a Nutshell
IRA loans don’t actually exist. You may be able to borrow from your 401(k) or withdraw funds from your IRA account without any penalty. While withdrawing funds from your IRA account is possible in certain circumstances, it may carry serious financial consequences.
Many people wonder whether they can take out a loan when they need cash and have funds available in their Individual Retirement Arrangement (IRA) account.
Unfortunately, whether you have a Roth or traditional IRA account, you cannot take out an IRA loan because it is not permitted. There are certain 401(k) accounts and employer-sponsored retirement plans, which allow for borrowing and repaying a loan over a period of time. But IRAs are not set up in this manner.
In fact, there are penalties to withdrawing funds from the IRA before attaining the age of 59 and a half. You may be able to withdraw money under certain exceptions without paying a penalty. However, you should understand the potential costs, risks, and disadvantages of withdrawing from your IRA.
Here's an in-depth look at the risks, options, pros, and cons to help you make an informed decision about borrowing from your IRA.
When Can You Access IRA Funds?
1. Short-Term Rollovers
You may be allowed to access funds using an IRA short-term rollover if you can pay back the amount within 60 days or less. These short-term rollovers are typically used by participants when they want to move money from an IRA or 401(k) to a new retirement account.
You can use a short-term rollover when you are considering consolidating multiple IRAs into one or moving to a different broker.
You get 60 days to put the money from your IRA into another qualifying retirement account using the short-term rollover option. The Internal Revenue Service (IRS) understands that participants can always change their minds and should have flexibility in moving money between different retirement accounts. Hence, they allow these short-term withdrawals from an existing IRA.
In fact, you are allowed to deposit the withdrawn money into the same IRA instead of getting a new one if you change your mind again. This provides participants an opportunity to use the money for a short period of time. An indirect rollover means the money would come to you directly instead of going to another account. This gives you a 60-day window to use the money without penalty.
However, nothing is without drawbacks and risks. These are a few significant risks of short-term rollovers:
There are certain exceptions to the 10% penalty on early withdrawals from an IRA before the age of 59 and a half. While you may still need to pay the ordinary applicable income tax on the distribution, you may be able to avoid the 10% penalty. These exceptions are:
2. Roth IRA Withdrawals
Roth IRA doesn’t work like traditional IRAs. Contributions to Roth IRA use after-tax dollars. You can take out the money tax-free if you wait until retirement age and meet other requirements. For instance, you need to have opened the account for a period no less than 5 years before the withdrawal.
You can withdraw the amount placed into IRA without incurring any penalties or paying any taxes even if you are below the age of 59 and a half.
This makes Roth IRA easily accessible whenever you need money. The best part is that the contributions you make in a year will not be counted towards the contribution cap for the year if you withdraw funds from the account before the tax-filing deadline of the year.
This is why it’s vital that you don’t withdraw any earnings. There is a 10% penalty if participants withdraw the money earned on investments. There are certain exemptions to the penalty rule, such as:
Also Read: Best Gold IRA Companies
Disadvantages of Withdrawing from IRA
There are ways to access money in a Roth or traditional IRA, but this is not always a smart idea. There are two major disadvantages to raiding your IRA:
1. Steep Penalties
You could get stuck paying the 10% penalty if you use the indirect rollover method to withdraw money from the IRA and are unable to re-deposit it within 60 days. You may incur this 10% penalty if it turns out that you don’t qualify for hardship exemption.
Another risk is that you may withdraw earnings along with the contributions from your Roth IRA. In addition, there is always the 20% interest that IRA plan administrators are supposed to hold back for tax purposes.
2. Potential Growth
The money you withdraw will be essentially out of circulation and won't be earning any returns. Your fund will not grow during that period. In addition, you won't be able to deposit the money if you withdraw from a Roth IRA which counts towards the annual cap.
This is true in the case of hardship distributions from a traditional IRA as well. You may end up losing out on potential gains the fund could have provided.
The Final Takeaway
There are ways to withdraw funds from your IRA account even if you cannot essentially take out a loan. Moreover, taking money from your IRA is a risky endeavor because of potential penalties and taxes and with inflation and high gas prices – that’s a terrible situation to be in. In addition, there is always a risk of financial shortfalls when you retire because of loss of growth opportunity.
You are essentially borrowing against your own financial security in the future when you take money out of a retirement account. Raiding your IRA should be kept as a last resort given the risks and drawbacks. You might consider using this option only when you have exhausted all other possibilities.