Can You Get a Loan From Your IRA Account?

Accessing funds from retirement accounts can be confusing. While direct loans from an Individual Retirement Arrangement (IRA) are not possible, employer-sponsored plans like 401(k)s often allow participants to borrow against their vested account balance. This article clarifies the distinctions between these account types and explains the rules and implications of accessing funds from each.

Understanding Retirement Account Loans

Individual Retirement Arrangements (IRAs), including Traditional, Roth, SEP, and SIMPLE IRAs, are for individuals to save for retirement. IRAs do not permit loans to the account holder. The Internal Revenue Service (IRS) views any attempt to borrow from an IRA as a prohibited transaction, leading to significant tax consequences and penalties. This is because IRAs are individual accounts without a plan administrator to manage the loan process, unlike employer-sponsored plans.

Employer-sponsored qualified retirement plans, such as 401(k)s, 403(b)s, and 457(b)s, are designed with provisions that may allow participants to take out loans. These plans have a designated plan sponsor and administrator who can oversee loan mechanics, including setting terms, collecting repayments, and ensuring compliance with IRS regulations. The ability to borrow from these accounts is a feature plans may offer, but it is not mandatory for all plans. Therefore, loan availability depends on each employer’s plan rules.

Rules for Retirement Plan Loans

For employer-sponsored plans that permit loans, rules govern how much can be borrowed and under what conditions. The maximum loan amount is the lesser of $50,000 or 50% of the participant’s vested account balance. An exception allows borrowing up to $10,000 if 50% of the vested balance is less than that amount.

Repayment terms generally require the loan to be repaid within five years. However, if loan proceeds are used to purchase a primary residence, the repayment period may extend up to 15 years, depending on plan provisions. Loan repayments must be made in substantially equal installments, at least quarterly, and are facilitated through payroll deductions. The interest rate charged must be reasonable and market-rate, with all interest payments credited back to the participant’s own retirement account.

Some qualified plans may require spousal consent before a participant can take a loan, particularly if the loan amount exceeds $5,000. If an employee leaves their job with an outstanding loan balance, the full remaining amount becomes due quickly. Many plans require repayment by the due date of the individual’s federal tax return for the year employment ended, including extensions.

Tax Implications of Retirement Plan Loans

Failing to repay a loan from an employer-sponsored retirement plan according to its terms leads to significant tax consequences. If the loan is not repaid by the specified deadline, the outstanding balance is treated as a “deemed distribution” from the plan. This amount becomes immediately taxable as ordinary income in the year it is deemed distributed. The tax and penalty reduce the amount available for retirement and can create an unexpected tax liability.

In addition to income tax, if the participant is under age 59½ at the time of the deemed distribution, a 10% early withdrawal penalty may also apply under Internal Revenue Code Section 72(t). If employment ends with an outstanding loan, and it is not repaid by the tax filing deadline of the following year (including extensions), the deemed distribution and associated penalties will be triggered.

Accessing IRA Funds Without a Loan

Since direct loans from IRAs are not permitted, the primary method for accessing funds is through distributions, also known as withdrawals. For Traditional IRAs, distributions are generally taxable as ordinary income. For Roth IRAs, qualified distributions are typically tax-free, provided conditions are met, such as the account being open for at least five years and the account holder being age 59½ or older.

Withdrawals taken from an IRA before age 59½ are generally subject to a 10% early withdrawal penalty, in addition to any applicable income taxes. However, the IRS provides several exceptions to this penalty. Common exceptions include distributions for a first-time home purchase, limited to a $10,000 lifetime maximum. Other exceptions cover qualified higher education expenses for the account holder or their family, and unreimbursed medical expenses exceeding 7.5% of adjusted gross income. Additional penalty exceptions exist for distributions due to disability, death of the IRA owner, or if taken as part of a series of substantially equal periodic payments (SEPP).

A temporary way to access IRA funds without incurring immediate tax or penalties is through a 60-day rollover. This involves withdrawing funds and redepositing them into another qualified retirement account or the same IRA within 60 days. This method carries risks, including potential tax withholding and a strict one-per-12-month period limit for IRA-to-IRA rollovers.