Can You Borrow From a SEP IRA? Rules & Alternatives

A Simplified Employee Pension, or SEP IRA, is a retirement savings plan available to self-employed individuals and small-business owners. These accounts allow for potentially higher annual contributions than traditional IRAs and are relatively easy to establish and maintain. For many account holders, the question of accessing these funds before retirement arises. This article explores the specific rules governing loans and withdrawals from SEP IRAs, the penalties for violating those rules, and other methods for accessing your money when needed.

The Prohibition on SEP IRA Loans

The Internal Revenue Code (IRC) prohibits borrowing money from a SEP IRA. This rule applies to all Individual Retirement Arrangements, including Traditional, Roth, and SIMPLE IRAs. Any loan attempt is classified by the IRS as a “prohibited transaction,” which has significant financial repercussions. The prohibition also includes pledging the assets in your SEP IRA as collateral for a loan. The IRS treats this action identically to a direct loan, and both trigger the same consequences.

Consequences of a Prohibited Transaction

Borrowing from your SEP IRA is a prohibited transaction with immediate tax consequences. The IRS treats the amount borrowed or pledged as a “deemed distribution,” meaning it is considered withdrawn even if you intend to repay it. The entire value of the IRA may even be treated as distributed as of the first day of the year the transaction occurred.

This distribution is added to your gross income and taxed at your ordinary income tax rate. If you are under age 59½, an additional 10% early withdrawal penalty also applies. For example, a 45-year-old in a 24% tax bracket borrowing $20,000 would owe $4,800 in income tax plus a $2,000 penalty. The transaction must be reported to avoid further fines.

Alternatives for Accessing Funds

Taking a Taxable Distribution

A direct way to access money is by taking a distribution, which is a permanent withdrawal. Withdrawals of pre-tax contributions and earnings are taxed as ordinary income. If you are under age 59½, the 10% early distribution penalty also applies. This provides immediate cash but reduces your retirement savings and results in a tax bill.

The 60-Day Rollover Option

You can use a 60-day rollover to access funds for a short period. This involves withdrawing money from your SEP IRA and redepositing the full amount into a qualified retirement account within 60 days. If completed correctly, the transaction is not taxed. The IRS permits this only once per 12-month period across all of your IRAs, and missing the deadline will cause the withdrawal to be treated as a taxable distribution.

Considering a Solo 401(k)

Self-employed individuals who anticipate needing to borrow from retirement funds might consider a Solo 401(k). Unlike IRAs, Solo 401(k) plans can offer participant loans, allowing you to borrow the lesser of $50,000 or 50% of your vested account balance. An exception may allow you to borrow up to $10,000 for smaller balances, if the plan document permits it.

The loan must be repaid with interest, usually over a five-year period, to avoid being treated as a taxable distribution. This alternative requires establishing the Solo 401(k) before you need to access funds.

Using Non-Retirement Sources

Before tapping retirement savings, it is prudent to explore conventional funding sources. Options like personal loans, business loans, or a home equity line of credit (HELOC) do not impact your retirement assets. While these loans have their own requirements and interest costs, they avoid the income taxes and penalties associated with using a SEP IRA.