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I need some cash, can I borrow from my IRA?

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Dear Dan,

Are the rules for borrowing against an IRA different from those about borrowing from a 401(k)? I may need some cash and my IRA rolled over from an old 401(k) is my only savings.  

-Pat

Dear Pat, 

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The loan rules between 401(k)s and IRAs are completely different. You cannot borrow from your IRA. To quote the IRS, “Loans are not permitted from IRAs or from IRA-based plans such as SEPs, SARSEPs and SIMPLE IRA plans. Loans are only possible from qualified plans that satisfy the requirements of 401(a), from annuity plans that satisfy the requirements of 403(a) or 403(b), and from governmental plans.” (IRC Section 72(p)(4); Reg. Section 1.72(p)-1, Q&A-2)

You do have access to funds in your IRA. Unlike retirement plans such as a 401(k), which only permit access in certain circumstances, IRAs give you complete freedom to get money whenever you want it. The tricky part can be the taxes.

You said the IRA came from a 401(k) rollover so chances are every dime in that account is pretax. If you simply take funds from the IRA, the distribution is taxable as ordinary income. If you are under age 59 ½, a 10% penalty will also be levied unless an exception applies.

The exceptions from the penalty for early distributions for 2023 include distributions due to the total and permanent disability of the IRA owner, qualified higher education expenses, qualified first-time home buyers, an IRS levy of the plan, unreimbursed medical expenses, health insurance premiums paid while unemployed, certain distributions to qualified military reservists called to active duty, and a series of substantially equal payments.

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Each of these exceptions has its own set of qualifying rules or limitations. For instance, the first-time home buyer exception is capped at $10,000 and if you start a series of substantially equal payments, those payments generally must continue a minimum of five years or until you turn 59 ½ whichever is later. These payments must be taken even if you find you no longer need the distributions, so this option is often a poor choice for short-term needs of younger taxpayers.

One method of tapping an IRA early for a short-term need is a traditional or “60-day rollover.” Here you take a distribution with you as the payee, meaning the check is made payable to you or the funds are deposited in a nonretirement account of yours. If these distributed funds are redeposited into an IRA within 60 days of receipt, no taxes apply.

Whatever portion of the funds are not redeposited in time becomes taxable income and the 10% penalty will apply if you are under 59½. Because of this, having taxes withheld on a distribution can be a mistake.

You can only do a 60-day rollover once within 12 months of any other 60-day rollover. So, if you did one nine months ago, you can’t do another for another three months. If it has been more than 12 months since your last 60-day rollover and you take a distribution today, you won’t be able to do another 60-day rollover for a year after this one is completed.

This 12-month rule only applies to 60-day rollovers. Other types of rollovers you may read about such as “direct rollovers” or “trustee to trustee transfers” can be done as frequently as needed. However, these rollovers do not provide you any access to the funds as the funds go directly from institution to institution. The payee is typically something like “Financial Institution For Benefit of John Doe IRA,” not you as an individual.

While IRA funds are available anytime and some of these rules can lower the tax impact, there can be terrific benefits to accumulating funds in IRAs until retirement. It is best to maintain reserve funds and investments outside of IRAs and retirement accounts in case access is needed prior to 59½.

If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line. 

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Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.



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