Usually I write about stuff that I recommend doing. In this post, I want to look at something that is possible, but not recommended under most circumstances. With hard economic times, there are a lot of people trying to find ways to borrow from their retirement funds. Many 401k accounts allow this, but what if your money is in an IRA? You’ll probably want to ask: “Can I borrow from my IRA?” Well, can you borrow from your IRA? Or perhaps, can you borrow against your IRA’s value? Technically, no. But there is a short-term loophole that you can use if you have no other option. In this post, we are going to explore the loophole.
Individual Retirement Accounts
An individual retirement account is a retirement account that you set up personally. The government created this to make it easier for people to invest money for retirement when their employers didn’t offer retirement accounts. Basically, when you contribute to an IRA, you don’t have to pay taxes now on the amount you put in. You have to pay taxes when you take it out. (A Roth IRA works in the opposite way–you pay taxes now, but not later.)
There are a number of stipulations and rules associated with it, but the two we are concerned about for this discussion are the rules related to borrowing. You aren’t allowed to use the IRA for collateral, so you can’t borrow against your IRA. You can’t borrow money directly from the IRA, either. If you take the money out before retirement, you have to pay taxes on the amount you took out, plus a 10% penalty. (There are a couple of exceptions where you can avoid the 10% penalty.)
Getting a loan from your IRA
However, the government does let you roll your IRA over from one account to another. Usually you do this by requesting a check from the old account and depositing it into the new account. The law says you have 60 days to accomplish the transfer. This is the loophole. The 60-day period is basically be a 60-day loan of the value in your IRA.
The 60-day rule isn’t there to let you take a loan, it is just there to let you transfer the money elsewhere. For most people looking for a way to borrow money from their IRA, this loophole is a really really bad financial idea. People looking for this type of loan are under financial distress with problems that aren’t going to suddenly clear up in 60 days. If they pull the money out, spend it and don’t pay it back they are going to be in a position of owing the IRS a significant amount of the IRA’s value. Assuming 30% tax rate, pulling out $10,000 would generate a $4,000 tax bill. Further, bankruptcy can wipe out a lot of bills and debts that cause financial distress, but not anything you owe to the IRS. So if you temporarily use the IRA money to pay other debts and then go bankrupt, you now have a debt that stays with you through bankruptcy.
When to borrow against your IRA
So, why would you want to use the 60-day rule to borrow money? The only way I can think of is if you had some type of financial opportunity that you wanted to take advantage of, but it would take you more than 60 days to arrange financing. For example, if you found your dream home as a foreclosure and wanted to quickly make a cash offer to a bank, you could potentially pull the money out of your IRA to buy the house, and then get a mortgage on the home to pay it back. There is still risk involved. Here are some things to ask yourself:
- Do you know you can obtain financing elsewhere?
- Are you sure you can complete the other financing approvals within 60 days?
- Are there any possible roadblocks you haven’t foreseen?
- Is it possible to borrow money elsewhere?
Even if you think you can pull it off, here are some things to watch out for:
- Setting up the IRA may take longer than expected. Make sure you know how long it takes from the time you give the broker a check to the time it shows up in your new account for IRS purposes.
- Understand the paperwork involved and have the account created ahead of time. You don’t want to take 61 days because the broker was sick or because you forgot about a holiday.
- Make sure you understand how long it will take to get your other funding and leave a margin for error.
So, even though this is possible, it is risky. If you need money, there are usually other options that come with much less risk. Here are a number of ideas:
- The original investment in a Roth IRA can be withdrawn without a penalty or taxes, so that might be an option.
- You may be able to borrow on margin against your stock portfolio.
- Don’t forget about family. There may be someone willing to loan you money where they aren’t going to charge you 40% if you take 61 days to pay it back.
So, there you have it–a way to borrow from your IRA. Once again, let me stress that 90% of the time, this is a very, very bad idea. However it is possible, and sometimes knowing what is possible can help you take advantage of rare opportunities that come your way.