When you are in need of money, digging into your retirement fund may be a tempting option. And since an IRA is one of your valuable assets, you might consider taking an IRA loan. But, can you take a loan from an IRA? Unfortunately, you cannot! Let's understand why and what are the alternatives to taking a loan from an IRA.
What Is an IRA Loan?
There is technically no such thing as an IRA loan because you cannot borrow from your IRA. It's against the IRS regulation. However, you can still leverage your IRA funds for investing in real estate. Let's discuss your options.
What Are the Alternatives to Borrowing Against Your IRA?
Since you can't borrow from your IRA, you can consider the following alternatives:
1. Roth IRAs: You can convert your traditional IRA account into a Roth. You can then take out the money from it without triggering any tax liability or penalty. Ensure that you seek help from a tax expert to know if that's an option for you.
2. Other retirement plans: You can borrow from your workplace retirement plans, such as 401(k). However, by borrowing from your retirement plans, you are taking several risks. Firstly, you are raiding your retirement savings, and secondly, if you are unable to pay off the loan, you may have to pay taxes and also penalties. And if you change your job, you may have to repay the loan in full.
You can consider moving your funds from an IRA into your 401(k). You will then have more money to borrow. Check up with your HR department or consult a financial planner or tax advisor to know the pros and cons of this technique.
3. Self-directed IRA: Using your self-directed IRA for buying real estate is the simplest and the most straightforward alternative to an IRA loan. It allows for a wide range of investments. If you open a self-directed IRA through a specialized firm, you can directly invest in real estate without breaking any IRA rules.
4. 60-day rollover: By using a 60-day rollover, you can borrow from your IRA for a short period. However, you need to ensure that you strictly follow the IRS rules. You are allowed to do a 60-day rollover once in every 12 months. If this is something you haven't done in a while, please revisit the IRS rules.
Understand the IRS Prohibited Transaction Rules.
Code Sections 408 & 4975 prohibits "disqualified persons" from engaging in certain types of transactions. Generally, your self-directed IRA cannot purchase collectibles, life insurance, or get involved in transactions that directly or indirectly benefit you or your lineal descendant ("disqualified person").
Pros and Cons of Investing in Real Estate Using Your IRA
- It diversifies your portfolio
- The property appreciates over time
- It provides steady rental income that grows tax-free within the IRA
- It allows you to buy, flip, sell and accumulate properties
- It requires you to set up a self-directed IRA with a custodian.
- It doesn't allow you to claim deductions for property taxes, depreciation, mortgage interest, and other real estate-related expenses.
- You must hire staff to maintain and manage the property, and the expenses have to be paid with your IRA funds.
- You and your relatives cannot directly or indirectly benefit from the property. You cannot live in it.
Using funds from your IRA to buy real estate is a popular option. But it is not for the faint heart or for people who are not savvy investors. Before you invest your IRA to buy real estate, do your due diligence and consult a tax professional for further guidance.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as Business.com, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday and NuWireInvestor. If you need help and guidance with traditional or alternative investments, email rick(at)sdretirementplans.com.