Can You Borrow From an IRA Without Penalties?

The Internal Revenue Service prohibits individual retirement account owners from borrowing against funds in their accounts. Still, a number of exclusions and workarounds can allow at least temporary use of IRA funds before reaching retirement age. The effort calls for care to avoid violating the rules banning loans when tapping IRA funds pre-retirement. Otherwise, the IRA owner could face significant penalties as well as taxes. For help saving for retirement, consider talking to a financial advisor.

IRA Loan Basics

Tax rules specifically bar all loans from IRAs. That includes SEP-IRAs, Simple IRAs and SARSEPs. Penalties for violations can be exceptionally severe. If an IRA owner does borrow from the account, according to the IRS, the IRA is no longer treated as an IRA. If that happens, the entire amount of the IRA becomes income, exposing the owner to a tax burden as high at 37%, the maximum marginal tax rate, on the IRA’s contents.

An IRA owner can’t use assets in the account as collateral to secure a loan either. If the account holder tries that, the portion of the IRA that was pledged as security will be treated as an early withdrawal.

Early withdrawals from IRAs generally incur significant added costs. Withdrawals taken before age 59.5 have to pay a 10% penalty. In addition, income taxes on the amount withdrawn are due at the recipient’s normal marginal rate.

IRA Loan Strategies

Several strategies can allow IRA owners to get around the rules banning loans without having to pay penalties. Some involve taking out what amount to short-term loans, while others take advantage of exemptions permitted under circumstances.

One approach that can let an IRA owner take out a long-term installment from IRA assts requires converting the IRA to a 401(k). Some 401(k) plans permit owners to borrow from their accounts. Principal and interest payments on 401(k) loans go back into the accounts.

The process of changing an IRA to a 401(k) is a reverse rollover. Reverse rollovers can provide other advantages, such as potentially allowing penalty-free withdrawals as early as age 55. However, several limits and drawbacks complicate reverse rollovers. The major limitation is that not all 401(k) plans allow loans.

In another approach, IRA owners can temporarily use account funds without penalties and taxes for up to 60 days by rolling over the account’s assets to another IRA. This sort of IRA rollover amounts to taking out a short-term loan that can be used for any purpose.

One advantage to an IRA rollover is that it involves no interest charges. The major disadvantage is that the rollover must be completed within 60 days. Any funds not placed in the new IRA within that time frame are treated as an early withdrawal and incur a 10% penalty and taxes.

IRA Early Withdrawal Exemptions

In addition to these loan possibilities, the following exemptions can allow IRA owners to take distributions that don’t have to be repaid:

Be over the age of 59.5: Six months after an IRA account holder’s 59^th birthday, withdrawals are penalty-free. Income taxes are still due at the regular rate.
Hardships: Withdrawals at any age avoid penalties under certain hardship conditions, one of which is the taxpayer becoming permanently disabled. Hardship withdrawals still owe income tax.
Higher education expenses: Having to pay for higher education for yourself or another family member is another hardship condition allowing penalty-free withdrawals.
Medical expenses: Costs of necessary medical care in excess of 10% of adjusted gross income can be paid with an un-penalized early IRA withdrawal.
First-time homebuyer: If you need money to buy your first home, you may be able to take an early IRA withdrawal of up to $10,000 without penalty.
Health insurance: An unemployed IRA owner can withdraw early to buy health insurance free of penalty.
Military service: Joining or being called up to active service in the military can qualify you to make an early withdrawal without penalty.
Lien for back taxes: You can use a penalty-free early withdrawal to pay back taxes if the IRS places a tax lien on your property.

Other, more involved strategies can allow you to make withdrawals without owing either penalties or taxes and sometimes both. They include:

Roth IRA conversion: If you pay the upfront tax costs to convert a regular IRA to a Roth IRA, after five years you can withdraw money free of taxes or penalties.
Standard deduction: If you have no taxable income, you may be able to withdraw IRA funds up to the amount of the standard deduction without owing taxes. Penalties may still apply.
Charitable donations: Donating securities from your IRA to a charity can provide a tax deduction that can shelter early IRA withdrawals from taxes but not necessarily penalties.

The Bottom Line

Although tax rules bar all loans from IRAs, account owners may be able to find ways to tap their retirement funds before reaching retirement age without incurring penalties. IRA rollovers, reverse rollovers to 401(k) plans, various hardship withdrawals and other strategies can permit retirement savers to borrow or make early withdrawals free of penalties and, in some cases, income taxes.

Tips for Retirement Planning

Before making any move with your retirement accounts, consider discussing the matter with a financial advisor. If you don’t have a financial advisor, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
The SmartAsset Retirement Calculator will tell you how much you need to save per month in order to have a comfortable lifestyle in retirement. The free online tool accounts for your location, annual income, anticipated age of retirement and other factors to lay out a clear financial road map to retirement.