Options for accessing IRA funds
Short-term rollovers
If you'll need a very short-term loan out of your IRA and can repay the cash quickly – within 60 days or less – you may be in a position to connect to the funds with an IRA rollover.
Rollovers can be used to move money from the 401(k) or IRA to a different retirement account, like when you want to move to a new broker or consolidate multiple IRAs into one. With a rollover, you take the cash out of your IRA and have Two months to place it into another qualifying retirement account.
The IRS recognizes that people can change their minds about moving money between retirement accounts after they've taken a withdrawal from a current IRA. So you're also permitted to return withdrawn money back into the same IRA instead of right into a new one. If you do an indirect rollover – meaning the distributed money comes first rather than heading in one IRA to a different – you could potentially use the money for Two months without penalty.
This approach has some significant risks and drawbacks, though. Here are some.
- 20% \”interest\” – Technically, you will not pay interest on rollover funds. But tax law requires IRA plan administrators to withhold 20% of indirect rollovers (whenever you cash out yourself) for taxes just in case you don't complete the rollover. Whenever you redeposit the money into an IRA, you'll have to repay the entire amount you withdrew, such as the 20% you didn't actually get. For example, if you indirectly roll over $5,000, you'll actually receive $4,000 and become necessary to redeposit $5,000 within 60 days. That comes down to repaying your personal funds at 20% \”interest.\”
- One-a-year limit – You're only permitted to do one rollover within a 12-month period, so that your capability to use this technique is limited.
- Fees – Plan administrators may charge administrative fees for rollovers.
- Taxes and penalties – If you can't redeposit the cash within Two months, the IRS will treat the transaction as an IRA distribution. The withdrawal will be taxed as income, and if you're younger than 59 1/2 you may also face a 10% penalty to make an early withdrawal.
Withdrawals for specific needs
While you're generally subject to a 10% penalty for early withdrawals from an IRA if you take money out before age 59 1/2 , there are several exceptions to this rule.
You'll need to pay ordinary tax in your distribution but could steer clear of the 10% penalty. Here are some of these exceptions.
- Total and permanent disability of the IRA owner
- Qualified higher-education expenses
- Up to $10,000 for qualified first-time homebuyers
- Unreimbursed medical expenses that exceed 7.5% of the adjusted gross income
- Health insurance costs while you're out of work
Roth IRA withdrawals
Roth accounts work differently than traditional IRAs. Whenever you deposit money right into a Roth account, you make contributions with after-tax dollars. Should you hold back until retirement and meet certain requirements, just like having the account open at least 5 years before withdrawals, you are able to remove money tax-free.
If you need to access funds from the Roth IRA prior to age 59 1/2 , you are able to withdraw the number you put in the IRA without having to pay taxes or incurring penalties. This makes it easy to access money you put to your Roth IRA account when you require it. And if you withdraw funds from the Roth IRA prior to the tax-filing deadline of the identical year you made the contributions, then they won't count toward your contribution cap for that year.
But you have to be careful to not withdraw any earnings. Should you withdraw money your investments earned, you'll be susceptible to the 10% penalty unless you fall under one of the following exemptions:
- Permanent disability
- Buying or creating a first home
- Paying for significant medical expenses (a lot more than 7.5% of your AGI)
- Paying medical health insurance premiums while unemployed
- Paying for higher-education expenses
Drawbacks of IRA withdrawals
Although you can access the money inside a traditional or Roth IRA, doing this often is not a wise decision. There's two primary explanations why you don't want to raid your IRA.
- You could face steep penalties. If you attempt to borrow from your IRA while using 60-day indirect-rollover method and don't put the money-back on time, you could get stuck paying the 10% penalty put on early withdrawals. You could also face this penalty if perhaps you don't squeeze into a hardship exemption or you accidentally withdraw earnings and not just contributions from your Roth IRA.
- You will lose out on potential growth. While the money is withdrawn, it will not be earning returns and growing to help fund your retirement. And when you withdraw contributions from the Roth IRA that count toward your annual cap or have a hardship distribution from your traditional IRA, you cannot place the money back, which means you lose out on all of the gains it could've provided prior to retirement.
Bottom line
Taking money from your IRA, whether as a withdrawal or an indirect rollover that you're planning to settle in Two months, is really a risky endeavor due to the potential taxes and penalties. As well as the loss of growth opportunity in the withdrawn funds can often mean you face financial shortfalls as a senior.
Perhaps there is a reason there's no such thing as an IRA loan – taking money out of a retirement account is borrowing against your own future financial security. Because of the risks and disadvantages, raiding your IRA should be a final resort once you've exhausted other options.
