Borrowing against Your IRA: 6 Common Questions about IRA Loan
IRA loans for property and investments may seem like a good idea, but there are some risks to consider. These 6 FAQs will help you understand more about them: IRA loans for property and investments may seem like a good idea, but there are some risks to consider. These 6 FAQs will help you understand more about them:
Can you take a Loan from an IRA and is it a Good Idea?
Technically, you can’t borrow against your IRA or take a loan directly from it. What you can do, however, is use the “60-day rollover rule” as a method of financing expenses, loans, or investments. Essentially, money taken out of an IRA can be put back into it or another qualified tax-advantaged account within 60 days, without taxes and penalties.
Here are a few ways you can borrow from your IRA without attracting a penalty:
- If you’re 59½ or above, you can request a distribution from your traditional IRA without any penalty. However, since your original contributions were tax-deductible, you’ll need to pay income tax on the money you pull out.
- However, if you own a Roth IRA, you can withdraw both contributions and earnings tax-free and penalty-free – if you are 59½ or above and have owned your Roth IRA for five years or more. With a Roth IRA, you can pull out the money from the account any time you want without any tax or penalty. However, you’ll have to withdraw only the contributions and not the investment earnings (such as interest you have earned on the contributions or dividends). If you withdraw the earnings early, you’ll have to pay a 10% penalty and also income tax on the amount you withdrew.
- If you can repay the borrowed money in 60 days or less, you can use the 60-day rollover rule to your advantage. The IRS allows you to roll money from one IRA to another or pull money out from your IRA as long as you put it back in the same IRA within 60 days. Follow this IRA 60-day rollover rule, and you will not have to pay taxes and penalties
Two conditions for 60-day rollovers:
- For tax purposes, your IRA provider may withhold 10% of your IRA money, provided you instruct it not to do it. When you put the money back into your IRA within 60 days, you must deposit the full original balance, plus the 10%. Or else, taxes and an early distribution penalty will be applicable to the portion that was withheld.
- If the money is not back into your IRA within 60 days, you’ll risk paying 10% penalty and taxes too.
The recently passed CARES act had changed some of the rules listed above. For this year, the 10% penalty does not apply. So someone under the age of 59 ½ can ask for a distribution without incurring the 10% penalty. If not replaced within 60 days, income taxes will be due. Although the 60 day rollover rule is in place, it should be a last resort for accessing funds. Too many unforeseen events could happen creating a tax nightmare. The CARES act now allows anyone to ask their IRA Custodian to effect a directed rollover to a self-directed ira or a self-directed 401 k up to $100,000.
When Should You Borrow against Your IRA?
Honestly, never. The risk is too great. That being said, the 60-day rollover period can help with a financial emergency or time-sensitive investment opportunity.
For instance, it can be helpful when you’re negotiating a real estate deal that you intend to finance with a mortgage, when you have no other source of funds for medical expenses, or are expecting a tax refund or money from other sources.
Explore all other avenues first, such as:
- Making a tax-free withdrawal from the initial investment in a Roth IRA
- Taking a loan on margin against stocks in your investment portfolio
- Loans from friends or family, who won’t charge you interest if you’re late by a day
Also, make sure that mortgages, other financing options or incoming funds with which you plan to pay back IRA loans will definitely be completed within 60 days. Leave room for potential setbacks such as public holidays and delays in paperwork.
What Happens if You Fail to Pay Back the IRA Loan?
If you fail to pay back your IRA loan within 60 days, the money will be treated as a taxable distribution from the account. If you’re under 59½ years of age, you will also be liable for a 10% early withdrawal penalty in addition to income tax. For this year, the CARES act has changed things a little. You may ask for a distribution up to $100,000, no 10% penalty and you have three years to pay the taxes OR put it back within three years and there will be no taxes or penalty! So you have a couple of choices, a direct rollover to another retirement plan or a distribution without the 10% penalty and three years to pay it back!
There are a few exceptions to the 60-day rollover requirement, like receiving incorrect advice from a financial advisor or falling sick. However, there’s no guarantee that you will qualify for an extension or waiver.
There’s one more risk to consider. In case you use IRA loans to tide you over during a bad financial time but go bankrupt during the 60-day rollover period, you will still owe the IRS any tax and penalty applied to the amount withdrawn.
Is There Any Penalty for Taking IRA Loans?
As long as you pay back the loan within 60 days, tax and penalties don’t apply, but you may be liable for a 6% excess contribution fine if you make more than one rollover within a 12 month period for each IRA.
What are the Qualification Criteria for an Ira to Borrow Money?
Certain lenders offer non-recourse IRA loans for the purchase of rental property, where property itself acts as security, instead of the account holder or IRA.
To qualify for an IRA non-recourse loan:
- The real estate investment must make financial sense – meaning positives cash flow
- You should have 15% of the loan amount as a ready reserve
- Most non-recourse lenders will lend up up 60 – 65% LTV (loan to value).
Therefor you must have 30%-40% of the property’s purchase price in a self-directed IRA, to cover down payment and fees
What is the Process for IRA Loans?
- Check if the property is eligible for financing, complete the loan application, and provide recent IRA statements to the bank. If you’re married, include your spouse’s name.
- Review the procedures and documents required by your IRA custodian. Complete and sign these, and get the real estate contract signed by the custodian.
- Coordinate with the custodian to get funds directly transferred from your IRA to the financing bank for fees and appraisals.
- Ensure that the IRA is listed as insured, with a minimum policy term of one year. Provide the bank with invoice and policy copies at least two weeks before closing.
- After the bank reviews your application, verifies your documents, orders an appraisal and confirms the closing date, you will be notified if your loan is approved.
- After approval, your IRA custodian should execute your real estate documents as “read and approved” before closing, and then transfer the down payment and closing fees directly from your IRA to the title company.