Sensible Perspectives

Need a Short-term Loan? How About an Interest Free Loan from Yourself?

Posted by on October 28, 2016

IRA loanYou accidentally took a $100k distribution from your Individual Retirement Account (IRA) and you are under the age of 59 ½. Oh no!  You’ve just incurred a 10% tax penalty in addition to the regular income tax on the distribution, right?  Maybe not.  If you return that $100k to the IRA within 60 calendar days (and you haven’t already done this in the last 365 days), you will owe no tax at all.

Congress may not have had precisely this scenario in mind when it permitted IRA account holders to “roll over” distributions within 60 days. Members probably wanted to give account holders ample time to transfer assets from one IRA to another, or from a 401(k) to an IRA.

Intentionally or not, however, Congress also created an opportunity for IRA account holders to provide themselves with 0% interest, short-term (60 days or less) loans.

Let’s think of a real life example. You are downsizing from a $1MM home to a $700k home. The sale of your $1MM home will not settle until a week after you close on your new home.  How can you pay for your new home without the equity from your old home?

You could obtain a short-term loan from a lender, or maybe borrow on margin from your brokerage account.  These are reasonable and potentially inexpensive options for very short-term loans, but they are not available to everyone, and they can take time and effort to execute.  If you have an IRA with $700k or more, you can borrow the full amount from that account and not pay a penny in taxes or interest.

Key considerations

You must address two issues before using this strategy:

  1. You must be confident that you will receive the money from the sale of your current home within the 60 day window to replace the distribution
    1. If you don’t return the distribution within 60days
      1. The $700k becomes taxable income
      2. You will be unable to return it to your IRA
    2. If you are younger than 59½ years old there would be an additional 10% penalty for an early distribution.
  1. You cannot have made any other rollovers that would fall under this rule in the last 365 days.
    1. You used to be able to repeat this process indefinitely with multiple IRAs.
    2. Since 2015, you can take advantage of the 60 day Rollover Rule for IRAs only once every year (no matter how many IRAs you have).
    3. There are some exceptions which will not count as a rollover for the purposes of this rule:
      1. Conversions from a qualified retirement plan (401(k), 403(b), etc.) to an IRA
      2. Trustee-to-trustee transfers (funds are transferred from one custodian to another – the IRA owner never holds the funds)
      3. Conversions from an IRA to a Roth IRA

As we’ve said, there will be no taxes due or interest owed if the “loan” is repaid within 60 days. You might incur some trading costs when selling securities and then again when reinvesting on returning the rollover. If you wire the money out of your account, the custodian may charge a fee.

Time is another consideration. It can take a few days to realize cash from selling your securities (ETF trades settle in 3 days) and then you have to get your cash from the custodian.  Linking your bank account to your IRA will likely make the process faster. A wire can settle same day.

In conclusion

If you find that you need cash relatively quickly, and you are confident that you will be able to return that cash within 60 days, “borrowing” from your IRA is an option you should discuss with your advisor.