Thinking About Borrowing from Your IRA? Be Very Careful…

Are you thinking about borrowing from your IRA for short-term cash needs? Your IRA can’t actually lend you money, so borrowing isn’t really the right word, but you can get around the IRS 60-day rule and avoid the penalty by withdrawing the funds and then quickly (key word!) restoring the identical amount to the account.

What Is the 60-Day Rule and Why Was It Created?

The 60-day rule gives savers 60 days to take a distribution from a qualified retirement account penalty-free, as long as those funds are re-deposited into a qualified retirement account before the deadline. The rule was created to give those who want to move their retirement funds to another account time to make that change without incurring penalties during the transition.

The only way to avoid the distribution becoming taxable is to return the funds to the same account or another qualified retirement account within 60 days.

What Happens When You Withdraw Your Funds?

When you withdraw funds from your IRA, after the 60-day deadline, the distribution becomes taxable– you will receive a 1099 form reporting the distribution from your plan administrator (and so will the IRS).

That 1099 will also reference a special code, alerting the IRS to assess a 10% penalty tax on that distribution, regardless of your age.

How Strictly is the 60-Day Rule Enforced?

The IRS frowns heavily on the practice of withdrawing qualified retirement funds for reasons other than taking a regular distribution in retirement, and is very reluctant to waive the 60-day rule. The rule is waived very rarely and only under specific circumstances.

One taxpayer recently found out about this the hard way: they paid for a PLR (Private Letter Ruling) and found out that the IRS had no mercy– although intent is often a key factor the tax court looks at when deciding cases, it was unfortunately no help in this case, and their situation wasn’t sufficient to qualify for a waiver of the 60-day rule.

In this case, the IRS refused to grant an extension of time to a woman who “borrowed” money from her IRA to buy her daughter’s home, which was in foreclosure. She intended to replenish her IRA with funds she was to receive from selling her vacation home. Due to some small delays, the sale didn’t close on time, so she was a few days late replenishing the funds.

The Bottom Line: If You “Borrow,” Make Sure You Return the Funds On Time

I’ve studied more cases than I can count where the facts were similar to these, and with very few exceptions, the IRS always wins when strictly enforcing the 60-day rule with no wiggle room allowed for unforeseen delays, even if it’s just a few days.

If you find yourself in this situation, it’s always a good idea to consult with a tax professional to see if your case might be one of those extremely rare exceptions. But generally speaking, in cases where you thought you could put back the money by the 60th day and for some reason can’t, the tax court usually sides with the IRS.

So if you are planning to borrow from your IRA, make sure you can return the money before the 60 days is up– otherwise, you should be prepared to pay the penalty.

Randy Newton is a South Carolina CPA and Tax Planning Specialist. You can read more of Randy’s posts about tax news and developments here and on the Lodestar Tax & Accounting.