Can You Borrow From an IRA?

Individual Retirement Arrangements (IRAs) serve as important tax-advantaged vehicles designed to help individuals save for retirement. They offer tax benefits, such as tax-deductible contributions or tax-free growth, depending on the IRA type. While IRAs are valuable for long-term savings, a common misunderstanding exists regarding the ability to “borrow” directly from these accounts like a traditional loan. Such direct loans are generally not permitted and can lead to significant tax implications and penalties.

Understanding Direct Access to IRA Funds

Unlike some employer-sponsored retirement plans, Individual Retirement Arrangements do not permit direct loans to the account holder. Any attempt to access funds from an IRA, unless it falls under specific rollover rules or qualified distributions, is considered a taxable distribution. This distribution is subject to ordinary income tax at the taxpayer’s marginal rate.

For individuals under age 59½, such distributions also incur an additional 10% early withdrawal penalty under IRC Section 72(t). This penalty aims to discourage premature access to retirement savings. Lending money from an IRA to the account owner or a disqualified person constitutes a “prohibited transaction” under IRC Section 4975.

A disqualified person includes the IRA account holder, their spouse, lineal descendants (children, grandchildren), lineal ascendants (parents, grandparents), and certain business entities. Engaging in a prohibited transaction can have severe repercussions. The IRA may lose its tax-exempt status, and its entire value can be treated as immediately taxable to the account holder, potentially resulting in substantial tax liabilities and penalties.

The 60-Day Rollover Rule

The 60-day indirect rollover provides the closest mechanism for temporarily accessing IRA funds without immediate penalty. This rule allows an individual to take a distribution from an IRA and redeposit the funds into the same or a different IRA within 60 calendar days. The primary purpose of this rule is to facilitate movement of funds between retirement accounts.

If the funds are not redeposited within the 60-day window, the distribution becomes fully taxable as ordinary income. If the individual is under age 59½, the 10% early withdrawal penalty will also apply to the distributed amount.

A significant limitation applies to the frequency of these indirect rollovers. IRC Section 408(d)(3)(B) limits individuals to one indirect rollover per 12-month period across all their IRAs. This means that if a taxpayer completes an indirect rollover from any of their traditional, Roth, SEP, or SIMPLE IRAs, they cannot perform another indirect rollover from any of their IRAs for a full 12 months from the date of the distribution.

This frequency limitation is strictly enforced across all of an individual’s IRAs. Failing to comply can lead to the distribution being fully taxable and subject to the early withdrawal penalty. Trustee-to-trustee transfers, where funds move directly between financial institutions, are not subject to the 60-day or one-per-year rollover limitations.

Circumstances for Penalty-Free Withdrawals

While direct borrowing is generally not permitted, certain situations allow an IRA holder under age 59½ to make a withdrawal without incurring the 10% early withdrawal penalty. It is important to note that these are not loans, and the distributed funds remain subject to ordinary income tax.

Medical Expenses and Higher Education

One exception applies to unreimbursed medical expenses exceeding 7.5% of the taxpayer’s adjusted gross income. Qualified higher education expenses for the IRA owner, spouse, children, or grandchildren can also be withdrawn penalty-free. The funds must be used for tuition, fees, books, supplies, and equipment required for enrollment or attendance.

First-Time Home Purchase

Another exception permits a penalty-free withdrawal of up to $10,000 for a first-time home purchase. To qualify, the individual (or their spouse) must not have owned a principal residence in the two years prior to the home acquisition date. This $10,000 is a lifetime limit for the individual.

Birth, Adoption, and Disability

The SECURE Act introduced an exception for qualified birth or adoption expenses, allowing a penalty-free withdrawal of up to $5,000 per parent, per child. The distribution must occur within one year of the child’s birth or the finalization of the adoption. Additionally, distributions made due to the IRA owner’s total and permanent disability are exempt from the penalty.

Death and SEPPs

Distributions to a beneficiary or the IRA owner’s estate after the owner’s death are also penalty-free. Finally, withdrawals made as part of a series of substantially equal periodic payments (SEPPs) can avoid the penalty. These payments must continue for at least five years or until the individual reaches age 59½, whichever period is longer, using an IRS-approved method.

Key Differences from 401(k) Loans

The rules governing access to retirement funds differ between Individual Retirement Arrangements and employer-sponsored 401(k) plans. A fundamental difference lies in the availability of direct loan provisions.

Many employer-sponsored 401(k) plans permit participants to take loans from their vested account balances. These loans are subject to specific Internal Revenue Service regulations, including limits on the maximum loan amount (the lesser of $50,000 or 50% of the vested balance) and defined repayment terms, usually over a five-year period. If the loan is repaid according to the terms, it is not considered a taxable distribution.

In contrast, IRAs do not offer a direct loan feature. Any money taken out of an IRA, other than through a qualified exception or a properly executed 60-day rollover, is considered a distribution. This distribution is immediately taxable as ordinary income and may be subject to a 10% early withdrawal penalty if the account holder is under age 59½. The primary purpose of an IRA is long-term retirement savings, not short-term liquidity, which is reflected in these differing access rules.