Borrowing from Retirement Plans

If you are unable (or prefer not) to borrow from a bank or other outside source, your qualified retirement plan may be a good option. IRS guidelines permit a limited amount of borrowing from corporate qualified retirement plans, including 401(k) plans. In general, borrowings are limited to 50% of the participant’s account balance up to a maximum of $50,000 and must be repaid within five years (unless the loan proceeds are used to purchase a principal residence). Hardship withdrawals (different from a loan, which must be repaid to the plan) from 401(k) plans are also permissible in certain circumstances. However, hardship withdrawals are taxable and subject to a 10% penalty if made before age 59½.

Tax law generally prohibits borrowing from IRAs. However, a distribution from an IRA followed by a redeposit of the funds into the same account or another IRA within 60 days of receipt of the funds will qualify as a tax-free rollover transaction. Once you have made such a tax-free rollover, you must wait at least one year from the date of receipt of the amount withdrawn from that particular IRA before becoming eligible to participate in another similar transaction. This once-per-year rule is applied individually to each IRA. Therefore, a person who has more than one IRA may make a rollover once per year on each account. Your use of the funds for the 60-day rollover period is, in effect, a short-term loan. It is recommended that you not implement this strategy without careful planning.

Example: Borrowing from an IRA.

Sue needs $8,000 to pay her income taxes on April 15th. Her only liquid asset is her IRA account with a balance of $63,000. However, she expects to receive an accident settlement of $20,000 around May 15th. Sue can take an $8,000 distribution from her IRA account and use these funds to pay her taxes due April 15th. If she redeposits the funds within 60 days, there are no tax consequences. She can use a portion of her settlement or other available funds for the redeposit to her IRA. If Sue does not receive her insurance settlement within 60 days and has no other source from which to repay the $8,000 distribution, severe tax consequences can result. The distribution becomes taxable and is subject to the 10% penalty if Sue is under age 59½.