Does an IRA Loan Really Exist?

There is really no such thing as an IRA loan. Many people get confused because there are options to borrow against a 401k. These do not apply with IRA accounts, which are subject to a totally different set of rules.

401k Loan

Some companies offer a chance to borrow from a 401k fund. This is not required by law, and not every company will provide this option. Even for the companies that do, they will limit the items you can borrow for. You will only be allowed to take the loan if it is going toward the purchase of a home or to pay off student debt. Even then, you will have to show you cannot get the funds from another source. You will be restricted to borrowing 50% of your total vested amount. While you have the money, you will not earn interest on it. Further, you will have to repay the loan in 5 years or be subject to early withdraw penalties. Since 401k contributions are not taxed on the front-end, you will have to pay taxes on the funds whenever you receive them in a loan.

IRA Withdrawal Options

IRA accounts are different from 401k accounts in a number of ways, but one of the key difference is an IRA is much more flexible. You can invest in a wider variety of options at a lower cost to maintain the account. Another advantage to the flexibility is the option to withdraw funds before the age of 59 1/1. You may withdraw the funds for up to 60 days. Some people think of this like "making a loan to yourself." As long as you return the funds within the 60 day period, you will be operating within the law. For example, if you need funds to immediately purchase a new home before your old home sells, you may consider the withdrawal. Then, when you sell your old home, you can use the proceeds from the sale to replace the funds in the account.

IRA Withdrawal Dangers

The above example relies on the fact you will make money in the sale of your home. This is not certain, and there are very few options for replacing the funds that are certain. If you do not replace the funds within 60 days, you will have to pay a penalty that is greater than the cost of nearly any loan you can take out. Further, while you have the funds, they will not be earning tax free gains in the account. Essentially, you are depriving yourself of the benefits provided in the tax code for your retirement. Because of these dangers and penalties, an IRA loan to yourself should only be considered in a situation where you cannot get the funds elsewhere and there is a very low risk of not returning the funds. Ultimately, you are bearing the burden of the risk, and you alone will have to pay the consequences if anything goes wrong. A lender is not splitting the responsibility of default with you like they would in a traditional loan.


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