Borrowing from IRA or using your IRA as collateral is normally not permitted. Prohibited transactions are subject to taxes and penalties imposed by the IRA account that you have. But there is a certain rule that allows you to borrow money from your IRA account. Through this you will find a way around any penalties or unnecessary fees but know that it should be strictly followed. Otherwise the tax advantages that you enjoy with your account will possibly vanish. There will be two rules, 60-day rule and 1-year rule.
60-Day Rule
Although borrowing money from IRA is made possible because of this rule, you should take it seriously. You will be allowed to borrow provided that you return the amount within 60 days starting from the date that you received the borrowed money. If in case you fail to do so then it will be deemed as prohibited transaction and you will be paying taxes and penalties most especially when your account has yet to reach its maturity. Paying a 10% early withdrawal penalty is the most likely to happen.
If you will be using the money for a first home purchase, an extension of 60 days will be added to the 60-day rule making the grace period to a total of 120 days.
1-Year Rule
The 60-day rule can only be used once every year. This is done so that individuals will not be able to abuse the short-term IRA loan. With two withdrawals in the same year, the second withdrawal will be branded as garden-variety distribution and will be taxed. The count for the 1-year rule will start from the date of reception of the money. Remember that these rules do not provide you with the right to make a loan but just the privilege to transfer the money elsewhere.
Borrowing from 401k
401(k) is a retirement plan that is controlled by your employer. With 401(k) you can have a loan up to as much as half of your principal’s total amount. An amount of $50,000 dollars accumulative loans in one year is the maximum per account holder. This account does not require lengthy approval that’s why you can get the money quickly. You will not be paying 10% penalty because technically you are not withdrawing money from your account. The one significant disadvantage of borrowing from 401(k) is that the money is considered no longer in your account making your interest rates lesser.
Penalty Exemptions
There are times that we really need to withdraw from our retirement plans to aid us in our financial constraints. This maybe because of emergencies, major health issues, personal issues or property purchases. Withdrawals made with these scenarios are termed as IRA hardship withdrawal or hardship loans and are as follows:
- Distributions made for direct rollovers to new account.
- Permanent disability.
- Paying health insurance after losing your job.
- Distributions made by beneficiaries of an inherited IRA.
- Distributions for first home purchase.
- Distributions for paying college expenses.
- Distributions for paying medical bills (amount exceeding 7.5% of gross income).
- IRS levies.
Tips and Warnings
Be very careful in borrowing from your retirement plans because in cases of bankruptcy, unlike any other debts, the amount that you owe with IRS because of taxes and penalties will remain. You will end up in much more dire financial situations even in bankruptcy status.
It’s always great advice to first seek a financial planner or retirement specialist before undertaking a risky venture that could ultimately cost you a good deal of your earned money.
