Considering borrowing money from your retirement savings account? Contributing to tax-advantaged accounts helps you grow wealth and prepare for a comfortable retirement. And while it’s important to grow the balance of these accounts, there could also be times when you have a greater need elsewhere. For example, maybe you need to borrow from your retirement account to cover a financial emergency.
While there are ways to access the money in your IRA, a loan isn’t one of them. However, there are other retirement accounts you can borrow money from, as well as other ways to get the money you need from your IRA.
Understanding IRAs
An IRA — short for individual retirement account — is a type of tax-advantaged account you can use to save for the future. Unlike other accounts like 401(k) plans, IRAs aren’t offered by an employer. Instead, individuals can open an IRA on their own directly through a brokerage firm, as well as choose all of their own investments.
There are two primary types of IRAs: traditional IRAs and Roth IRAs. A traditional IRA is a pre-tax account. You can deduct your contributions, and your earnings will grow tax-deferred in your IRA. However, you’ll pay income taxes on your withdrawals. A Roth IRA, on the other hand, doesn’t allow you to deduct your contributions. However, you won’t be taxed on your investment growth or withdrawals.
Read more: Roth IRA contribution limits 2023
In 2024, the IRS allows you to contribute up to $7,000 to your IRA (up from $6,500 in 2023). If you’re 50 or older, you may contribute up to $8,000.1 However, your ability to contribute or to deduct your contributions may be impacted by your income.
There are also some types of IRAs that are specifically designed for self-employed individuals and small business owners. Those IRAs, including SEP IRAs and SIMPLE IRAs, have different rules regarding eligibility, contributions, and more.
What is a retirement plan loan?
Simply put, a retirement plan loan is a loan that you take from a tax-advantaged retirement account. It differs from other types of loans in that you are both the lender and the borrower. You take the loan by withdrawing money from your plan, and as you repay the loan, it goes back into your retirement account, along with interest.
Retirement plan loans offer flexibility in that you can access the money you’ve saved for retirement and use it for other purposes. And unlike early withdrawals, there are no tax consequences or penalties. However, because you’re taking money from your retirement account — even if only temporarily — you can’t invest it and let it grow for the future. Ultimately, this can reduce the amount of money you have available during retirement.
Can you borrow from an IRA?
The short answer is that no, you can’t borrow from an IRA. This prohibition on IRA loans applies to all types of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs.
If you attempt to borrow from your IRA — even if it’s only a portion of your balance — the account will no longer be considered an IRA. The entire balance is considered a distribution and is included in the account holder’s income.
How to access the money in your IRA
Unlike employer-sponsored retirement plans like 401(k)s, IRAs don’t allow plan loans. Any time you take money from your IRA, it will be considered an early withdrawal and will be taxed as such. The consequences of that will depend on the type of IRA you have.
Traditional IRA
First, you can technically withdraw the money in your traditional IRA at any time. Because the money was contributed pre-tax, you’ll pay income taxes on all withdrawals. Additionally, if you take any distributions before age 59 ½, you’ll pay a 10% penalty on the full withdrawal amount.
For example, let’s say you withdraw $10,000 from your traditional IRA to pay for an emergency. If you’re in the 22% tax bracket, you’ll pay $2,200 in income taxes. You’ll also pay $1,000 in additional penalties. Of the $10,000 you withdrew from your account, you’ll end up paying $3,200 to the IRS, meaning only $6,800 stays with you.
Roth IRA
The withdrawal rules for Roth IRAs work differently because of the after-tax nature of their contributions. First, you can withdraw your Roth IRA contributions at any time without paying taxes or penalties. To withdraw your investment earnings, you’ll need to meet the following requirements:
- It’s been five years since you first contributed to the Roth IRA
- The distribution occurs:
- After you turn 59 ½
- Because you’re disabled
- Because the account owner has passed away
- To purchase a home ($10,000 limit)
If you withdraw your Roth IRA earnings without meeting the requirements for a qualified distribution, you’ll pay the same 10% early withdrawal penalty that applies to early traditional IRA withdrawals. Additionally, you’ll pay income taxes on the Roth Earnings, which you wouldn’t have to do on qualified Roth IRA withdrawals.
Read more: What is a Roth IRA?
Penalty exceptions
Early withdrawals from your traditional and Roth IRAs are subject to a 10% early withdrawal penalty. However, the IRS offers a few exceptions that allow you to access your money early without penalties. Those exceptions are:
- You withdraw up to $5,000 for qualified birth or adoption expenses
- The IRA owner has passed away and you’re the beneficiary
- You’re totally and permanently disabled
- You withdraw up to $22,000 for disaster recovery in a federally declared disaster area
- You’re the victim of domestic abuse and withdraw up to $10,000 or 50% of the account, whichever is less
- You use the money for higher education expenses
- You use the money for a personal or family emergency (limited to once per year)
- You take a series of substantially equal payments
- You withdraw up to $10,000 to buy your first home
- There’s an IRS levy on your plan
- You pay for unreimbursed medical expenses of more than 7.5% of your AGI
- You pay for health insurance while you’re unemployed
- You’re a qualified military reservist
Borrowing from a 401(k) - An alternative to IRA loans
You can’t borrow money from your IRA, but you can borrow from your 401(k) plan, which is an employer-sponsored retirement plan offered by many for-profit companies. The IRS allows 401(k) loans, but it’s up to each individual plan administrator to decide whether to allow them for their plan.
If your 401(k) plan allows loans, you can borrow the lesser of $50,000 or 50%2 of your vested balance. For example, if you have $100,000 vested in your account, you can withdraw $50,000. However, if your account balance is lower, you’ll be more limited in how much you can borrow.
401(k) loans aren’t considered withdrawals and aren’t taxable, but they do require interest. The good news is that because you’re both the borrower and the lender, the interest you pay is deposited into your 401(k) plan, along with your principal payments.
401(k) loans must be repaid within five years using substantially equal payments. These payments must be paid at least quarterly but can be made more often.
If you fail to repay your 401(k) loan on time, the unpaid amount will be considered an early withdrawal. You’ll pay income taxes on that amount, as well as a 10% early withdrawal penalty.
Finally, if you leave your job — whether you quit voluntarily or are let go — you may have to repay the full loan balance immediately. If you can’t repay the loan, it will be considered a distribution, and you’ll have to pay taxes and penalties.
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Weighing your options
When you need fast access to cash, it can be difficult to know what the best decision is.
If you need money and your only option is to take money from your retirement accounts, you might be weighing two different options:
- Take a withdrawal from your IRA
- Take a loan from your 401(k)
Both of these options have financial consequences. An early withdrawal from your IRA could be subject to taxes and penalties. Meanwhile, though a 401(k) loan doesn’t have tax consequences, you will have to pay interest on the loan. Additionally, by taking the money out of your account, even if only temporarily, it’s no longer able to grow.
If you must choose between an IRA withdrawal and a 401(k) loan, the loan is often the preferred alternative because you ultimately return the money to your account and avoid taxes. However, you might decide to take an IRA withdrawal instead if you have Roth IRA contributions you can withdraw tax-free, or if you meet one of the IRA penalty exceptions, such as buying a home or paying for higher education.
Finally, make sure to consider your other alternatives. There are plenty of loan types that are easily accessible and can be used for any purpose. These loans may be preferable to a 401(k) loan or IRA distribution if you’re able to qualify for one. Here are a few loan alternatives to consider:
- Personal loan: A personal loan is a fixed-rate installment loan that you can use for any purpose. Though personal loan rates are typically higher than the APR you’d pay on a 401(k), they are lower than credit card rates. Personal loans come in amounts as high as $100,000, so you can borrow more than you could from your 401(k).
- Home equity loan or HELOC: Home equity loans and HELOCs are secured by your home, just like your mortgage. As a result, they often offer lower interest rates than unsecured loans. Home equity loans are fixed-rate loans, while HELOCs — short for home equity lines of credit — are revolving credit lines, just like credit cards.
- 0% APR credit card: Credit cards generally aren’t the best option if you can’t repay your balance right away, but an exception is a 0% APR offer, which some card issuers offer when you sign up for the card. You can use a 0% APR card for a large purchase and balance transfer and pay it off without paying interest.
- Peer-to-peer loan (P2P): A P2P loan allows you to borrow directly from another person rather than a bank. P2P lending is usually done through an online marketplace that connects borrowers and lenders. A P2P loan could be a good alternative to a traditional bank loan if you’ve struggled to qualify for one.
The bottom line
A retirement plan loan allows you to access the money in your tax-advantaged account without having to take a taxable distribution. However, IRAs don’t allow loans — any money you take from your account is considered a distribution and may be subject to taxes and penalties.
There are plenty of alternatives to IRA loans, including borrowing money from your 401(k) loan. However, due to the downsides of taking money from your retirement plan, you may be better off considering alternatives such as personal loans, home equity loans, 0% APR credit cards, and peer-to-peer loans.
No matter what you decide, it’s important to weigh your short-term and long-term goals. Consider how you can get the money you need today without sacrificing your retirement goals.
