Can you borrow money from your Roth IRA?
The decisive answer is yes! …and no.
Why both? Because, while you can't take a loan from your Roth IRA like you can with other retirement accounts such as your 401k, you can withdraw funds tax-free, penalty-free, and interest-free for short periods of time. So if you find yourself in dire straits, your Roth IRA can serve as a sort of de-facto emergency fund.
Tax Free Roth IRA Withdrawals
If you find that you're in dire need of money, and you've depleted your liquid savings, you have the option to make tax-free, penalty-free withdrawals from your Roth IRA.
Under IRS rules, you can withdraw your original Roth IRA contributions tax-free and penalty-free at any time and for any reason. However, this only applies to your original principal contributions, not any money you may have since accumulated in your Roth IRA as a result of interest, dividends, capital gains, or other earnings.
If you withdraw any funds from your Roth IRA other than your original contributions before you've reached age 59 ½ and before meeting the requirements of the Roth IRA 5 year rule, then you will likely owe income taxes and a 10% early withdrawal penalty.
Need an example? Let's say you're 47 years old, you're in the 35% tax bracket, and you have a Roth IRA worth $120,000 – a figure which includes $50,000 in original contributions as well as $70,000 in capital gains, interest, and dividends.
Under such a scenario, you can withdraw your original after-tax contributions tax-free and penalty-free. In this case, that's any amount up to $50,000. But if you withdraw any part of the remaining $70,000 in earnings, you'll owe income taxes and a 10% penalty on early Roth IRA distributions.
For instance, let's say you have an emergency and you withdraw $60,000 from your Roth IRA. You'll end up paying $4,500 in taxes and penalties. Why? Because the first $50,000 is tax and penalty-free because you're simply withdrawing your original after-tax Roth IRA contributions. However, the next $10,000 you withdraw is subject to income taxes at your 35% bracket ($3,500) as well as a 10% early withdrawal penalty ($1,000).
So keep in mind, if you're caught in a pinch financially, you can always withdraw your original Roth IRA contributions tax-free and penalty-free. But there is a downside if you choose to do this – in most cases, you can't put the money back! And that robs your long-term retirement plan in favor of today's short-term gain.
Borrowing From Your Roth IRA
Under IRS rules, you can't borrow funds or take a loan from your Roth IRA. However, as we previously discussed, you can withdraw your original Roth IRA contributions tax-free and penalty-free. This is fine if you simply wish to withdraw those funds forever, but what if you only need them short-term and you just want to temporarily borrow some funds from your Roth IRA? Can you put those contributions back?
Not always. The only circumstance in which you can put back money you've previously withdrawn from your Roth IRA is when you withdraw funds you already contributed in the current tax year and you're then re-contributing to your Roth IRA in the same tax year. Under IRS rules, you can make a Roth IRA contribution for a given tax year anytime between January 2nd of the year in question and your tax filing deadline the following calendar year. In most years, this makes April 15th the deadline for making a contribution.
Does all that make sense? If not, let's look at an example.
Let's say at the beginning of the year things are going great for you financially. You anticipate things will continue to go great, and so you make a $5,000 Roth IRA contribution on January 5th. However, by the time November rolls around, you've been unemployed for several months, and you've burned through your savings. In order to make ends meet, you withdraw the original $5,000 Roth IRA contribution you made on January 5th. While the money is tax-free and penalty-free with no strings attached, you still want to contribute to your retirement and you'd like to put the money back if at all possible.
Then in December, you get a new job! As a result, you might have the means to put back the $5,000 you withdrew from your Roth IRA November. If so, you can contribute up to $5,000 to your Roth IRA anytime before April 15th and designate those funds as contributions toward the previous tax year. This then allows you to make additional Roth IRA contributions during the current calendar year.
Pay Yourself Back!
While the above provision allows you to “borrow” interest-free money from your Roth IRA, it's not a risk free proposition.
Unless you pay yourself back prior to the Roth IRA contribution deadline, you lose the ability to make that particular contribution forever! While you can continue to make Roth IRA contributions year after year well into the future, you can never turn back the clock and restore the contribution you took out but failed to return in time. This then becomes a lost opportunity to save for your retirement, and you'll pay for it dearly in your later years.
So if you're considering a temporary withdrawal of your Roth IRA funds – make sure you pay yourself back! Otherwise, you're simply trading your tomorrow for today. Don't be so foolish and short-sighted. Instead, look to the wisdom of the ant:
“Go to the ant, thou sluggard; consider her ways, and be wise: which having no guide, no overseer, or ruler, provideth her meat in the summer, and gathereth her food in the harvest.” Proverbs 6:6-8
This is an article from Britt at http://www.your-roth-ira.com, the Web’s #1 resource for Roth IRA information.