When a Roth IRA Loan Makes Sense

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Updated on Friday, February 15, 2019

Investing money into your Roth IRA can be a big step in creating a solid financial future. The contributions you make into your Roth IRA come from your after-tax income. Once the money is contributed, you are able to withdraw your contributions with relative ease. However, you may have to pay penalties if you take any of the capital gains out of your account before the age 59 and a half.

Throughout your life, there will be moments when it’s tempting to tap into those funds, though it may be better for your long-term financial success to avoid tapping into your Roth IRA. Keeping your retirement funding goals on track is critical to successfully retiring on time with sufficient funds. Each time you tap into your Roth IRA, you may be pushing your retirement date further away.

That being said, you may not have a choice. If you truly need access to cash and have no other options, tapping into your Roth IRA may become a necessity. But before you head down this path, understand that choosing to take out a Roth IRA “loan” is not like other traditional loans. When you withdraw the money from your IRA you may have to pay taxes and fees, but you don’t have to repay the amount with interest like a traditional loan.

Maybe you need to fund a medical emergency or need the cash to recover from a natural disaster. Whatever event happens, it’s important to be aware of your Roth IRA withdrawal options.

Can I withdraw from my Roth IRA without a penalty?

Yes, it is possible to take money out of your Roth IRA without a penalty. However, there are rules that need to be followed.

For example, you can take out the contributions you made to your Roth IRA at any time without a penalty. Remember, you already paid taxes on these contributions, which is why you are able to withdraw this portion penalty-free.

After you have withdrawn an amount equal to your original contributions, you will be left with the earnings made by your investments in your account. If you choose to take out the investment gains, then you may have to pay a 10% penalty in order to gain access to the money.

However, in some situations, you may be able to waive the penalty. For instance, first-time homebuyers or those who survive a natural disaster might be able to withdraw penalty-free funds. (More on that below.)

A final way to withdraw money from your Roth IRA is to stay within the confines of the 60-day rollover rule. You have the option to take money out of your Roth IRA without penalty if you deposit the funds into another qualified retirement account within 60 days.

If your financial emergency will be short-lived, then this option might make sense. However, if you don’t redeposit the cash within the 60-day deadline, the withdrawal could be subject to penalties. It’s a risky move if you are unsure if the funds can be replenished within 60 days, so think carefully before using this option.

When does a Roth IRA withdrawal make sense?

Life events and emergencies that require money will pop up from time to time. However, not every emergency is a good reason to take money out of your Roth IRA.

“The Roth IRA should be your last go-to source for emergency funds,” said Adam Beaty, a certified financial planner at Bullogic Wealth Management. “You can take out a loan for an emergency, you cannot take out a loan for retirement.”

But there are some scenarios where tapping into your Roth IRA could be useful. Here are some situations to consider:

    • First-time home buyer. If you’ve decided to make your first home purchase, you are able to take out up to $10,000 of your Roth IRA without paying the 10% penalty. You can withdraw both your contributions and your earnings, though you may be required to pay taxes on your earnings if the account is less than five years old.
    • You have a permanent disability. If you become disabled, you’re able to take any distribution from your account without the 10% penalty. This includes both your contributions and your earnings, though you may be required to pay taxes on your earnings if your account is less than five years old.
    • You’ve experienced a natural disaster. If you encounter a natural disaster and need the funds to rebuild your life, then tapping into your Roth IRA could be an effective solution to your immediate problems. The IRS may allow you to take out a “qualified disaster distribution” without imposing the 10% penalty, but you could be required to pay taxes on the distribution.

Before you decide to withdraw money from your Roth IRA for disaster-related expenses, make sure that the reason is qualified as defined by the Internal Revenue Service (IRS). Typically, the IRS will announce whether or not a particular natural disaster qualifies for this kind of distribution within a few weeks of the event. You can find this information on the IRS tax relief page.

  • You need to fund educational expenses. Investing in yourself through education may be your next step towards the future. However, paying for that education can be expensive. You may be able to take money out of your Roth IRA for qualifying higher education expenses without having to pay the 10% penalty, though you may be required to pay taxes.
  • You are over the age of 59 and a half and the account has been open for more than 5 years. If you fall into this category, then you are able to take your earnings out of a Roth IRA at any time. You will not have to pay taxes or penalties on the withdrawal. Waiting until this age gives you more flexibility in how you use the money.

Bottom line

Using your Roth IRA to fund certain life events could be a good option for some. However, you will be affecting your retirement account in a negative way each time you make a withdrawal. Think carefully about your reasoning before you decide to make a withdrawal or not.