Before addressing the question of how to borrow from a Roth IRA, here's a quick refresher on how a Roth works. Contributions to a Roth IRA are not tax deductible when you make them. However, your distributions will be tax free, as long as you’re over age 59½ at the time. This untaxed status applies to both your original contributions and the gains on them.
What’s more, unlike traditional IRAs, you never have to take required minimum distributions (RMDs) from Roth IRAs. In fact, if you don't need the money, you can leave the whole account to your heirs.
- IRS rules do not allow you to borrow from a Roth IRA in the same way that you can borrow from and repay a 401(k).
- Early withdrawals from a Roth IRA (before age 59½) carry a 10% penalty.
- As long as money taken from a Roth IRA is replaced or rolled over into another qualified retirement account within 60 days, there is no penalty.
- Distributions for purposes such as buying a first home or certain medical expenses can qualify for no-penalty withdrawals, but only if the Roth IRA has been open for five years or more.
Borrowing from a Roth IRA
Technically, you can’t take out a loan from a Roth IRA. But you are free to withdraw your contributions at any time without paying penalties. (If you want to withdraw the earnings on your contributions, however, you may have to pay a 10% penalty.) There is also a way to work around the IRS’s requirements if you only need to borrow money for a short period of time. In either case, you'll need to work with the financial institution that handles your Roth IRA to make sure you fill out the proper forms.
According to the IRS, you can make a tax-free withdrawal of some or all of the money in your Roth IRA as long as you put the money back into the same Roth IRA or into a traditional IRA within 60 days. This is called a Roth IRA rollover and it's often used to transfer 401(k) funds when you change jobs or want more investment choices than your 401(k) provides. When the money is given to you to be deposited into your account, it's called an indirect rollover.
If you can't repay the full amount within 60 days, you have the option to repay a partial amount. However, you'll have to pay a 10% penalty on the portion of the money that you keep. In addition, there is a one-year waiting period between rollovers. The waiting period begins when you receive your distribution—not when you pay the money back.
Remember that any money you take out of your Roth IRA and don't replace will be that much less you'll have for retirement someday.
If you need to use more than the contributions you've made to your Roth IRA and won’t have the funds to repay the money within 60 days, you can make an early withdrawal. Most early withdrawals are subject to a 10% penalty. Or, you may be able to take a qualified distribution and avoid paying the penalty as well as taxes on the earnings if it’s been more than five years since you set up and contributed to your Roth IRA and one of the following circumstances applies:
- The distribution is being used to buy, build, or rebuild your first home
- You’re at least 59½ years old at the time of the distribution
- You've recently become disabled
Keep in mind that withdrawing money from your Roth IRA isn't the best way to get a loan, especially if you can't repay it within the 60-day window. Not only might you be subject to penalties and taxes, but funds taken out of the account won't be earning tax-free returns and helping to build your retirement savings.
Silber Bennett Financial, Los Angeles, CA
Loans are not allowed from IRAs or IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRA plans. Loans are allowed from qualified plans that satisfy the requirements of 401(a), annuity plans that satisfy the requirements of 403(a)s or 403(b)s, and governmental plans.
That said, the principal amount of a Roth IRA may be withdrawn without any tax consequence because you have already paid taxes on those funds...but the amount that your IRA has appreciated is not available for withdrawal without paying certain types of taxes and fees.
There are also exceptions, such as when you convert the funds from a traditional IRA into a Roth IRA, then the converted amount may not be available for penalty-free withdrawal for five years.