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Sometimes unexpected events can leave you short on money and scrambling to find some extra cash. Retirement accounts are a natural place to look, but unfortunately the IRS does not allow you to borrow money or take out a loan from any type of IRA. However, there are some ways to tap your IRA funds early without penalty, but there are strict rules that you’ll need to follow.
Here’s what you need to know about accessing money held in retirement accounts early and the rules for avoiding taxes and penalties.
Ways to access your IRA money early
IRAs serve as a long-term savings vehicle, which means there are restrictions on making withdrawals prior to reaching age 59 ½. However, once you reach that age, withdrawals can be made at any time for any reason. Withdrawals from a traditional IRA will be taxed at ordinary income rates, while Roth IRA withdrawals are tax-free if certain requirements are met.
If you need to tap your IRA funds early, you’ll typically pay taxes on the withdrawal and a penalty of 10 percent, but there are some ways around this:
Roth IRA contributions
Money that you’ve contributed to a Roth IRA can be withdrawn at any time tax-free. Keep in mind that this applies only to your contributions, not to investment gains you’ve seen in the account. Because the contributions were made with after-tax dollars, the withdrawals are tax-free.
There are some circumstances where the IRS allows you to withdraw money from your IRA without paying a penalty, though you’ll still need to pay taxes on the amount you withdraw. The following situations allow for penalty-free withdrawals from your IRA:
- Qualified higher education expenses
- First-time homebuyers up to $10,000
- Series of equal payments
- Unreimbursed medical expenses
- Distributions to qualified military reservists called to active duty
One way to tap your IRA that is similar to a loan is to complete a 60-day rollover. You’ll receive a distribution from your IRA that will need to be rolled into an IRA or another retirement plan within 60 days of receiving the distribution or you’ll owe taxes and a penalty on the withdrawal. If you can use the money and replenish the distribution within the time period, the transaction can function as an interest-free loan.
Here are some other things to be aware of with 60-day rollovers:
- The 60-day rule can be waived under certain circumstances.
- Taxes may be withheld from your IRA distribution unless you elect out of the withholding or request an alternative amount to be withheld.
- Only one IRA-to-IRA rollover is allowed in any 12-month period regardless of the number of IRAs you own.
- Watch out for withdrawal charges from the IRA custodian.
- If you fail to rollover 100 percent of the proceeds, the difference will be taxable and subject to the 10 percent additional penalty.
Unlike with IRAs, you are able to borrow from your 401(k) plan, but it shouldn’t be something you’re doing often. A 401(k) loan functions similarly to other loans, but you’re borrowing from yourself instead of a bank or traditional lender. You’ll have to pay interest on the loan and will typically need to pay it back within 5 years, though in certain instances the timeframe could be longer (if you use the funds to buy your main home) or shorter (if you leave your job).
If you don’t pay the loan back on time, it could qualify as a distribution, requiring you to pay taxes and penalties on the withdrawal. The loan amount is limited to $50,000 or 50 percent of your vested account balance, whichever is less.
Keep in mind that money in retirement accounts should be left alone if possible. These accounts come with tax advantages and are designed to help you save and compound your money over decades to prepare for retirement. Taking money out of these plans, even if just temporarily, interrupts the compounding process and could prevent you from achieving your financial goals down the road.
While it’s not possible to borrow from your IRA, there are ways to tap your retirement accounts early without penalty. A 60-day IRA rollover may be an option if you can quickly replenish the funds used, but failing to complete the rollover within 60 days will likely result in taxes and a penalty.
Borrowing from your 401(k) plan is an option, but you’ll pay interest on the loan and risk missing out on compounding your investment returns. Money in retirement accounts is best used for saving for retirement, but the funds can come in handy if you’re in need of cash.
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