Can You Take a Loan Out of Your IRA?

Individual Retirement Arrangements (IRAs) are designed for long-term retirement savings, offering tax advantages. A common question is whether one can borrow from these accounts, similar to a 401(k). Direct loans from an IRA are generally not permitted under tax law, a key difference from employer-sponsored plans.

Why Direct IRA Loans Are Not Allowed

IRS regulations prohibit direct loans from IRAs. This restriction stems from their primary intent as long-term retirement savings vehicles. Allowing loans would undermine their tax-advantaged status and could lead to misuse as short-term funding sources.

Unlike employer-sponsored plans like 401(k)s, which may include provisions for participant loans, IRAs lack this feature. The Internal Revenue Code does not provide for IRA loans. Attempting to borrow directly from an IRA can lead to severe tax consequences, as it is considered a prohibited transaction.

The 60-Day Rollover Exception

While direct loans from an IRA are not permitted, some individuals use the 60-day indirect rollover for temporary access to funds. This process involves withdrawing funds from an IRA and then redepositing the entire amount into the same or another eligible retirement account within 60 calendar days. If executed correctly, this transaction avoids immediate taxation and penalties.

Strict rules govern this exception. The IRS limits individuals to one indirect IRA-to-IRA rollover within any 12-month period. The 60-day deadline is absolute; if the funds are not fully redeposited by the 60th day, the entire withdrawn amount is treated as a taxable distribution. This means the amount becomes subject to ordinary income tax and, if the individual is under age 59½, an additional 10% early withdrawal penalty will also apply.

Understanding IRA Withdrawals

Accessing IRA funds typically means taking a distribution or withdrawal. Distributions are broadly categorized into qualified and non-qualified. Qualified distributions, generally taken after age 59½, or due to disability or death, are tax-free for Roth IRAs (if certain conditions are met) and taxable as ordinary income for Traditional IRAs, without an additional penalty.

Non-qualified, or early, distributions occur when funds are withdrawn before age 59½ and do not meet specific criteria. Such withdrawals are subject to ordinary income tax and an additional 10% early withdrawal penalty. Specific exceptions to this penalty exist, though income tax usually still applies unless it’s a Roth IRA contribution. Common exceptions include withdrawals for a first-time home purchase (up to $10,000), qualified higher education expenses, certain unreimbursed medical expenses, or if distributions are part of a series of substantially equal periodic payments.

Prohibited Transactions and Their Severe Consequences

Individuals must be aware of “prohibited transactions” involving their IRA. These are specific actions forbidden by tax law that can lead to severe penalties. A prohibited transaction involves the improper use of an IRA account or its assets by the IRA owner, their beneficiary, or a “disqualified person.” Disqualified persons include certain family members (spouse, ancestors, lineal descendants, and their spouses) and fiduciaries of the IRA.

Examples of prohibited transactions include borrowing money directly from the IRA, pledging IRA assets as collateral for a loan, or engaging in certain transactions with disqualified persons, such as selling property to or leasing property from the IRA. If a prohibited transaction occurs, the entire IRA account is immediately disqualified, retroactively to the first day of the tax year in which the transaction took place. This means the entire fair market value of the account is considered a taxable distribution on that date, subject to ordinary income tax. If the IRA owner is under age 59½, the full 10% early withdrawal penalty will also be applied to the entire account balance, regardless of the amount involved in the specific prohibited transaction.