Retirement Accounts, Retirement Planning, Taxes

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Are IRA loans allowed from a traditional, Roth, SEP, or SIMPLE?

If you’re in need of money, certain retirement plans allow you to borrow from them, but that list doesn’t include traditional or Roth IRAs. Also, it doesn’t include IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs. According to the IRS, loans are available to plans that fulfill the requirements of 401(a), annuity plans satisfying 403(a) or 403(b), and from governmental plans (IRC Section 72(p)(4); Reg. Section 1.72(p)-1, Q&A-2, Reg. 116495-99).

As such, you can borrow from a 401(k), 401(a), 403(b), 457(b), Thrift Savings Plan (TSP), and other defined contribution retirement plans as well as defined benefit pension plans. But, that’s only if your employer or non-profit organization allows it, which they are under no obligation to.

Maximum Loan Amount

The maximum loan amount you can withdraw from your defined contribution retirement plan depends on your balance, but is the lesser of the following:

  • 50% of your vested account balance; or
  • up to $50,000.

The only exception to the 50% amount is if the balance is less than $10,000. Plans are not required to include this exemption and you’ll need to check to be certain. Here are a few examples to see the differences:

Example #1: Balance of $40,000

An employee has a balance of $40,000 in their 401(k) plan and their employer allows loans. The employee may take a loan of up to $20,000 since 50% is the lesser amount.

Example #2: Balance of $400,000

An employee has a balance of $400,000 in their 403(b) and their non-profit organization allows loans. The employee may take a loan of up to $50,000 since it is the lesser amount.

Loans must be repaid within five years and payments need to be made quarterly and interest is paid with after-tax money. The only exclusion to the 5-year rule is if the loan is used to purchase a primary residence. Although more than one loan can be made, the collective balance can’t exceed the maximum amount.

With a defined benefit pension plan, you will have to borrow from a pension funding organization instead of your account balance. While there aren’t limits on loan amounts, employers may impose a cap on how much can be borrowed.

Traditional, Roth, SEP, SARSEP, and SIMPLE IRAs

Contrary to many other defined contribution retirement plans, all IRAs — including traditional, Roth, SEP, SARSEP, and SIMPLE — are excluded from loans. You can do a penalty-free withdrawal if you’re at least age 59 ½, meaning it’s exempt from the 10% early withdrawal penalty. However, withdrawals are subject to both federal and state income taxes.

Exceptions to the 10% early withdrawal include the following:

  • Total and permanent disability according to IRC 72(t)(2)(A)(iii);
  • An alternate payee under a Qualified Domestic Relations Order (QDRO) according to IRC 72(t)(2)(C);
  • Qualified higher education expenses according to IRC 72(t)(2)(E);
  • Substantially equal payments according to IRC 72(t)(2)(A)(iv);
  • Up to $10,000 per individual ($20,000 per couple) for qualified first-time homebuyers according to IRC 72(t)(2)(F);
  • Up to $5,000 per individual ($10,000 per couple) for qualified birth or adoption of a child according to Section 113 of the SECURE Act;
  • Amount of unreimbursed medical expenses greater than 10% of adjusted gross income (AGI) for 2021 according to IRC 72(t)(2)(B);
  • Health insurance premiums paid while unemployed according to IRC 72(t)(2)(D); and
  • Certain distributions to qualified military reservists called to active duty according to IRC 72(t)(2)(G).

Other exclusions are 60-day rollovers and inherited IRAs. It’s important to note that if you’re a spouse, the sole beneficiary, and treat an IRA as your own (no longer classified as an inherited IRA), you’ll be subject to the 10% early withdrawal penalty if under age 59 ½.

Unless a Roth IRA, withdrawals are subject to both federal and state income taxes. A Roth IRA also needs to satisfy the 5-year rule for the distribution to be tax-free (only once for both contributions and conversions).

60-day IRA Rollover

Often, IRA loans are mistaken with the 60-day IRA rollover, which allows you a short period to access all of your balance. The 60-day IRA rollover is only allowed once per year— or once per 365 days. If a second rollover is made during the same time period, it will be subject to both federal and state income taxes as well as a 10% early withdrawal penalty if under age 59 ½.

A 60-day IRA rollover can be used to your advantage as long as you return those within 60 days from the date the withdrawal was received. Be careful when doing this as the time period might expire and you’ll be obligated to pay taxes (and possibly a penalty).

Traditional IRA to Employer Plan Rollover

If none of the prior options are enough, an alternate solution would be to do an IRA to employer plan “reverse” rollover, which is the process of moving an existing IRA balance to your 401(k), 401(a), 403(b), 457(b), Thrift Savings Plan (TSP), or other defined contribution retirement plan. The only caveat is that your employer would have to accept incoming funds. Make sure to check if this is allowed as some plans will and others won’t.

The IRS Rollover Chart will assist when deciding which retirement plans have the ability to be rolled over to other types. Before making any sudden choices, it’s best to understand both the potential tax and penalty consequences for making the wrong decision.

About the Author

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Carlos Dias Jr.

Carlos Dias Jr. is a financial advisor, public speaker, and president of Dias Wealth, LLC. Carlos is a nationally syndicated contributor for Kiplinger and has contributed, been featured, or quoted in several publications including Forbes, MarketWatch, Bloomberg, CNBC, The Wall Street Journal, U.S. News & World Report, USA Today, and others. He’s also been interviewed on various radio and television stations. Carlos is multilingual, fluent in both Portuguese and Spanish.

Retirement Accounts, Retirement Planning, Taxes

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Carlos is a very professional and knowledgeable financial planner. He focused on my financial goals and answered all my questions. He helped me better understand my future retirement plans, as well as how my life insurance policy was set up. Truly thankful for Carlos and his team.

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