You’re probably like many Americans with your 401k’s and IRA’s being your largest pool of assets. Therefore, in times of financial trouble, you may want liquidity from your IRA. Due to the possible negative effects on your retirement savings, and the associated tax implications, I don’t recommend this course of action. However, if you’re in this situation and thinking about using your IRA for a short-term loan, here are some guidelines you need to know.
Liquidity from your IRA
Some 401k plans include provisions where you can take loans, but IRAs are different. IRA’s don’t have loan provisions. In fact, the IRS may consider your loan a full distribution of your account and subject to the subsequent taxes and perhaps a 10% penalty.
Because IRAs don’t have loan provisions like your 401k, the only way you can access IRA funds on a short-term basis is through a 60-day rollover. In this scenario, you take a distribution, use the funds as needed, and replace the full withdrawal amount within 60 days. The rules don’t prohibit you from taking a distribution whenever you want, for any purpose you choose. There’s no rule limiting what you can do with your money while it’s out of your IRA either. Technically, you can take money from your IRA as a short-term loan using the 60-day rollover rule. However, failure to return the money to your account within the 60-day window means the loan is considered a distribution, and it’s taxable.
While this short-term withdrawal strategy is doable, is a good idea? Doing a 60-day rollover can be tricky. You have to follow many rules. For example, there is the Once-Per-Year Rollover Rule. This rule limits you, with some exceptions, to one IRA rollover in a 365-day period. If you fail to comply with this rule, or any other rollover rule for that matter, your distribution is considered taxable and subject to penalty if you are under age 59½. This mistake cannot be fixed.
There are other concerns such as the 60-day rollover deadline. You must deposit the funds back into your IRA within 60 days from the day you make the distribution. So, what if you don’t have the money to deposit by the rollover by the deadline? In this scenario, you face a taxable IRA distribution and potential early distribution penalties. Don’t expect any sympathy from the IRS either. There are many Private Letter Rulings on the subject, and the IRS refuses to grant relief. In addition, a failed short-term loan isn’t on the list of reasons IRS allows late rollovers through the self-certifications procedures.
So, here is the bottom line. You can use your IRA for a short-term loan through a 60-day rollover. However, the risks are extremely high. If things don’t go as planned, you could face a tax bill and the loss of your retirement savings. While possible, taking a loan from your IRA is seldom a wise decision. If you feel your situation requires liquidity from your IRA, please seek guidance from a professional about your individual circumstances.