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Can You Borrow From Your IRA?
Dear Carrie: I know you can borrow from a 401(k), but can you also borrow from an IRA? And if so, could I take $3,000 out of my Roth and return it within 60 days without penalty? — A Reader
Dear Reader: Let me start by saying that I always caution against taking money from your retirement accounts early —penalty or no penalty. The whole point of having a 401(k) or an IRA is to prepare for the future. And now more than ever, we all have to make sure our financial futures are covered.
However, I understand there are times when the ability to use your retirement funds for just a short time can make all the difference. And if you have no other options, it's possible to do just that — provided you follow all the rules to a tee.
A ROLLOVER FOR 60 DAYS OR LESS
You're right that you can take a five-year loan from many 401(k) plans without penalty as long as you pay it back on time. An IRA doesn't have a similar loan provision, but you can access money from your IRA for a 60-day period with what is considered a tax-free rollover. This essentially means you can withdraw money from your IRA tax- and penalty-free as long as you put it back into the same or a different IRA within 60 days.
The IRS is very particular about timing— 60 days is the absolute limit, and it starts on the day you receive your money, no exceptions. If you don't put the money back into an IRA within that time period, it's treated as an ordinary withdrawal subject to regular income taxes and a 10 percent penalty if you're under age 59-and-a-half. Plus, you lose the chance to put the money back.
And this isn't the only restriction. There's also what's called the one-year rule. You can only use a tax-free rollover in a specific IRA once within a 12-month period, beginning on the date you receive your money. Any other withdrawal within that time will be subject to applicable taxes and penalties. Also — and this is important — even if you redeposit the money into another IRA, the account that received the money is subject to the same one-year rule beginning on the date you received the money, not the date you re-deposited it.
As you can see, while on the surface a tax-free rollover may seem like an easy way to cover your short-term cash needs, it can get complicated — and costly — if you lose track of time.
WAYS TO MAKE PENALTY-FREE WITHDRAWALS
Once you reach 59-and-a-half, you can take penalty-free distributions from either a traditional or Roth IRA at any time, but you may have to pay income taxes (non-deductible contributions can be withdrawn tax-free).
If you're younger than that, there are other penalty-free withdrawals you may qualify for, including:
—First-time home purchases, subject to a lifetime limit of 10,000 in pre-tax dollars.
—Higher educational expenses for you and your immediate family.
—If you're disabled.
—If you use the funds to pay unreimbursed medical expenses in excess of 7.5 percent of your adjusted gross income (AGI).
—To pay health insurance premiums for yourself, your spouse or your dependents if you're unemployed for at least 12 weeks.
—If you elect to receive your funds on a regular distribution schedule, which the IRS calls "substantially equal periodic payments."
But again, while there's no penalty on these withdrawals, you may have to pay income taxes.
THE ADVANTAGE OF A ROTH
These rules apply to both traditional and Roth IRAs, but there's one advantage to a Roth — regardless of your age — that may mean you don't have to worry about the rules at all. With a Roth you can always withdraw your contributions without paying taxes or penalties. So if you've contributed more than $3,000 to your Roth and you really need the money, it's yours to take. The only "penalty" is the loss of any potential tax-free growth. To withdraw earnings , however, you must be at least 59-and-a-half and the funds must have been in the account for at least five years.
IRA regulations and tax implications are complex, so I recommend that you talk to a tax advisor before taking any action. And taxes and penalties aside, I really encourage you to look at all your alternatives before tapping into your IRA. While it may seem like a good solution, if money is tight now, how can you be sure it won't still be tight in 60 days? And if you miss the 60-day deadline, you'll pay a 10 percent penalty on top of your tax bill. Think carefully and be cautious. This is about your future as well as your present financial needs.
Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER(tm), is president of Charles Schwab Foundation and author of "It Pays to Talk." You can e-mail Carrie at firstname.lastname@example.org. This column is no substitute for an individualized recommendation, tax, legal or personalized investment advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.
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