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Loans From Retirement Accounts

1 August, 2014

Loans from Retirement AccountsDuring times of difficult financial periods, people often must turn to unconventional ways to find cash.  If you have been working in a particular industry perhaps you have a 401K.  Or perhaps you have been diligent in funding an IRA.  The money is yours right, so why not tap into it?  Not so fast, there may be consequences.

There is a big difference in the eyes of Uncle Sam between a 401K and an IRA.  In the case of a 401K you can actually take a loan against your account.  There are restrictions but you can actually borrow money from the account and then pay yourself back with interest.  Sounds like a great deal huh?  Not always.  If you leave your job, that loan could become due much faster and if you cannot pay it back, you have to pay a penalty just as if you had withdrew the funds rather than taken out a loan.

In the case of an IRA a loan from the account is always prohibited.  If you take money from your IRA account you have to pay the 10% early withdrawal penalty as well the regular income tax due on the distribution.  While this may seem unfair compared to an employer sponsored 401K plan, the tax courts have not wavered on this position.  Even dire situations caused by job loss or sickness do not exempt you from this penalty.  If you have a normal IRA account it is best to avoid any early withdrawals if at all possible.

However, if your IRA is a ROTH IRA you may be in luck.  A ROTH IRA does allow you to withdrawal any amount you have contributed to plan tax free and without penalty.  This is because you have contributed income that has already been taxed into a ROTH IRA.  For example, lets say you have contributed $5000 to your ROTH IRA over the last several years and that amount has grown to $6000.  You can take out the $5000 investment without penalty thus leaving $1000 in your ROTH account.  This is yet another advantage of having a ROTH IRA.



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