Can You Borrow From an IRA? What to Know

An Individual Retirement Arrangement (IRA) is a tax-advantaged savings vehicle designed for retirement. Direct loans from an IRA are generally not permitted by the Internal Revenue Service (IRS); any money taken is considered a “distribution” subject to specific rules and potential tax consequences.

Understanding IRA Distributions

IRA distributions are subject to different tax treatments depending on the type of IRA. For a Traditional IRA, contributions may have been tax-deductible, so distributions are taxed as ordinary income. Roth IRAs operate differently, as contributions are made with after-tax dollars. Qualified distributions, including contributions and earnings, can be entirely tax-free if conditions are met, such as the account being open for at least five years and the owner being age 59½ or older. Original Roth IRA contributions are always tax-free and penalty-free, regardless of age or how long the account has been open.

Accessing Funds Without Immediate Penalty

While direct loans from an IRA are not allowed, specific situations permit accessing funds without incurring the additional 10% early withdrawal penalty. One mechanism is the 60-day indirect rollover, which allows an individual to withdraw funds from an IRA and redeposit them into another IRA or qualified retirement plan within 60 days to avoid taxes and penalties. If the funds are not returned within this 60-day window, they become a taxable distribution, potentially subject to penalties. The IRS limits this type of IRA-to-IRA rollover to once in any 12-month period.

The IRS recognizes several exceptions that waive the 10% early withdrawal penalty for distributions taken before age 59½:
Distributions up to $10,000 for a first-time home purchase.
Qualified higher education expenses for the account holder, spouse, children, or grandchildren.
Distributions for unreimbursed medical expenses exceeding 7.5% of adjusted gross income.
If the IRA owner becomes totally and permanently disabled, distributions are also exempt from the early withdrawal penalty.
Distributions made to beneficiaries after the IRA owner’s death.
The Substantially Equal Periodic Payments (SEPP) rule, under IRS Section 72, allows for penalty-free withdrawals if a series of payments are taken over a period based on life expectancy.
Distributions for health insurance premiums while unemployed.
Qualified reservist distributions.
Qualified birth or adoption expenses.

Consequences of Early or Non-Qualified Withdrawals

When an IRA withdrawal does not qualify for a penalty exception or is not rolled over within the 60-day window, incurs significant financial repercussions. Distributions from a Traditional IRA are fully or partially taxable as ordinary income. If the distribution is from a Roth IRA and consists of earnings, it may also be taxable if the account has not met the five-year holding period or the owner is under age 59½.

An additional 10% early withdrawal penalty, under IRS Section 72, applies to distributions taken before age 59½ that do not meet one of the specific exceptions. The penalty is imposed on the taxable portion of the withdrawal. For example, a $10,000 early distribution from a Traditional IRA that is fully taxable could result in $1,000 in penalties, in addition to the income tax owed.

These distributions are reported to the IRS on Form 1099-R, which details the gross distribution, taxable amount, and a distribution code indicating the reason for the withdrawal. If the early withdrawal penalty applies, individuals may need to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. Taking money from an IRA prematurely also diminishes the account’s balance, potentially impacting its long-term growth and the individual’s future retirement security.

Exploring Other Financial Options

Since direct borrowing from an IRA is generally not permitted, individuals seeking funds often explore alternative financial solutions. One common alternative is a 401(k) loan, which some employer-sponsored plans allow. Unlike IRA distributions, a 401(k) loan is a true loan with repayment terms and interest, typically allowing borrowing up to $50,000 or 50% of the vested balance, whichever is less.

Personal loans from banks or credit unions offer another option, providing a lump sum that can be used for various purposes. These loans typically have fixed interest rates, which can range from approximately 8% to 36%, depending on the borrower’s creditworthiness.

Home equity loans or Home Equity Lines of Credit (HELOCs) allow homeowners to borrow against the equity in their property. A home equity loan provides a lump sum, while a HELOC offers a revolving credit line. Both use the home as collateral and may offer lower interest rates than unsecured personal loans.

Credit cards might be considered for immediate, smaller needs, but they often carry high interest rates, particularly for balances carried over time. Each of these alternatives has its own terms, interest rates, and risks, requiring careful evaluation based on an individual’s financial situation and needs.