Can You Borrow From an IRA?

What is the penalty for early IRA withdrawals?

The federal government imposes a 10% penalty for most IRA withdrawals before you reach age 59 1/2 (with some exceptions), and the money you withdraw is taxed as income. There’s also an opportunity cost to consider. The money you remove from the account will no longer accumulate returns, which can substantially limit your retirement account’s growth.

If you withdraw from your IRA before you’re 59 1/2, you’ll typically have to pay a 10% penalty on top of income tax.

Noah Schwab, owner of Stewardship Concepts Financial Services, said one of his clients experienced these consequences firsthand when the client withdrew $5,000 to help cover expenses between jobs.

“Being under 59 1/2, the client had a 10% penalty and 12% income taxes,” Schwab said. “Withdrawing $5,000 meant their take-home amount was $3,900. The biggest consequence was the potential growth of that money in retirement. If they had an 8% annual return, over 30 years, a $5,000 distribution is a loss of $50,313.”

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How to withdraw from your IRA without penalty

There are some ways you can withdraw money from an IRA without penalty, such as if you qualify under a specific circumstance or if you wait until you’re 59 1/2 years old.

Meeting a qualifying circumstance

You can generally qualify for a hardship distribution if you have an immediate and heavy financial need. Some qualifying circumstances that let you know withdraw money from an IRA without penalty include:

• Unreimbursed medical expenses
• First-time home purchases
• Certain educational expenses
• Being a qualified military reservist

A Roth IRA withdrawal

If you’ve had a Roth IRA open for at least five years, you can withdraw contributions, but not earnings, at any time without penalties or taxes. This makes a Roth IRA an attractive option for those needing to access their funds before retirement age.

A 60-day rollover

The 60-day rollover allows you to withdraw funds from your IRA and then redeposit them into another qualifying retirement account within 60 days. This can be a useful short-term solution for financial needs, provided the funds are returned within the specified time frame to avoid penalties.

Waiting until age 59 1/2

If you wait until you’re 59 1/2 years old to make IRA withdrawals, you won’t incur the 10% early withdrawal penalty.

Death or disability

If you become totally and permanently disabled, you may be able to make penalty-free withdrawals from your IRA. Additionally, if the owner of an IRA passes away, the beneficiaries can generally withdraw the funds without incurring the 10% early withdrawal penalty.

Alternatives to borrowing money from an IRA

Withdrawing from your IRA is not the most cost-effective way to borrow money, especially if you don't have a qualifying circumstance. Instead, you may want to consider taking out a personal loan or home equity line of credit (HELOC), or borrowing money from a different type of retirement account.

Personal loans

If you opt for a personal loan, stay away from lenders that advertise flexible requirements but charge rates higher than 35%.

Taking out a personal loan can be a faster way to access funds for immediate financial needs, such as home repairs or an emergency, without impacting your retirement savings. This option tends to be a cost-saving option only when you can secure a low interest rate, whether because rates are low or you have an excellent credit score.

Home equity line of credit

If you own your home, you can tap into its equity through a home equity line of credit. This line of credit has a draw period of up to 10 years, during which you can access funds as needed. After the draw period, there’ll be a repayment period.

The downside of using a HELOC is the potential risk of losing your home if you can’t meet the repayment terms. Additionally, fluctuating interest rates can lead to higher payments over time.

401(k) and 403(b) loans

401(k) plans and 403(b) plans may include a loan provision that lets you borrow funds without a penalty or withdrawal taxes. You’ll have to pay back the money borrowed (plus interest) within five years, but because you’ll borrow the money from yourself, interest payments are credited to your account.

According to the Internal Revenue Service (IRS), the maximum amount you can borrow from a qualified 401(k) or 403(b) account is the greater of $10,000 or 50% of your vested account balance, or $50,000, whichever is less.

Keep in mind that taking a withdrawal from your 401(k) or 403(b) account comes with some risk.

“Be careful with these types of loans,” said Justin Stevens, president of O’Keefe Stevens Advisory, a financial planning company. “401(k) and 403(b) loans typically can only be repaid through payroll. If you leave your job, the balance of the loan is due immediately.”

FAQ

Bottom line

If you’re thinking of taking an IRA withdrawal before you’re 59 1/2 years old, this might not be the wisest financial decision, even if you’re using the funds for a pressing need. Other financing options will allow you to avoid the 10% IRS penalty and keep your retirement savings growing. You may want to consider using a HELOC or personal loan before you turn to borrowing from your retirement account.

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