When unexpected events leave you in need of extra cash, your retirement accounts may seem like a tempting source. However, borrowing money or taking out a loan from an IRA is not allowed by the IRS. But there are ways to access your IRA funds early without facing penalties, as long as you follow the rules.
Here’s what you need to know about accessing your retirement funds early and the rules to avoid taxes and penalties.
Options for Early Access to IRA Funds
IRAs are intended for long-term savings, which means there are restrictions on making withdrawals before age 59 ½. However, once you reach that age, you can withdraw funds at any time for any reason. Withdrawals from a traditional IRA are subject to ordinary income tax rates, while withdrawals from a Roth IRA are tax-free if certain conditions are met.
If you need to access your IRA funds early, you will typically pay taxes on the withdrawal and incur a 10 percent penalty. However, there are exceptions:
Roth IRA Contributions
Withdrawals of contributions made to a Roth IRA can be done tax-free at any time. It’s important to note that this applies only to the contributions, not the investment gains in the account. Since the contributions were made with after-tax dollars, the withdrawals are tax-free.
Penalty-Free Withdrawals
There are certain circumstances where the IRS allows penalty-free withdrawals from an IRA, although taxes still apply. The following situations permit penalty-free withdrawals:
- Disability
- 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
60-Day Rollover
A 60-day rollover is a way to access your IRA funds that is similar to a loan. You receive a distribution from your IRA, which must be rolled into another retirement plan within 60 days to avoid taxes and penalties. If you can repay the distribution within the specified timeframe, it can function as an interest-free loan.
Here are some important considerations regarding 60-day rollovers:
- The 60-day rule can be waived under certain circumstances.
- Taxes may be withheld from your IRA distribution unless you opt out or request a different withholding amount.
- Only one IRA-to-IRA rollover is allowed within a 12-month period, regardless of the number of IRAs you own.
- Be aware of withdrawal charges from the IRA custodian.
- Failing to roll over 100 percent of the proceeds will result in the remaining amount being taxable and subject to a 10 percent penalty.
401(k) Loans
Unlike IRAs, you can borrow from your 401(k) plan, but it’s not something you should make a habit of. A 401(k) loan operates like any other loan, except you are borrowing from your own account rather than a traditional lender. The loan must be repaid with interest within five years, with some exceptions for longer or shorter repayment periods based on certain circumstances.
If you fail to repay the loan on time, it may be treated as a distribution, subjecting you to taxes and penalties. The loan amount is limited to $50,000 or 50 percent of your vested account balance, whichever is lower.
It’s important to remember that retirement account funds should ideally be left untouched. These accounts offer tax advantages and are meant for long-term savings to prepare for retirement. Withdrawing from these accounts, even temporarily, disrupts the compounding process and may hinder your financial goals in the future.
Conclusion
While borrowing from your IRA is not an option, there are ways to access your retirement funds early without penalties. A 60-day IRA rollover can be a viable choice if you can quickly replace the withdrawn funds. However, failing to complete the rollover within 60 days will likely result in taxes and penalties.
Borrowing from your 401(k) plan is a possibility, but it comes with interest payments and the risk of missing out on investment returns. Retirement account funds are best utilized for retirement savings, but they can provide financial assistance in times of need.
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