"Borrowing Money" from an IRA

Unlike your employer plan, borrowing from your Traditional IRA is a no-no. In fact, attempting to do so can get you disqualified and will result in taxes on a forced distribution. How would this happen? Well, using the example of movement we described above, some folks try to use the 60-day rollover feature as a free, short-term loan. If the same amount is removed wrong, the tax implications are triggered.

However, there is a way around this. Remember, the key words were the “same amount.” If you have a total amount of $50,000 and you take out $25,000, you have 60 days to deposit it back in a Traditional IRA account. So you do so. However, the other $25,000 is still available for the same feature. As a result, you could in effect create a $25,000 loan over 120 days planning this method out correctly. This is a simplistic approach, but with large amounts you can see the possibilities quickly. It also requires discipline to return the money rolled because one mistake triggers the distribution and tax penalty.

Taxes

As we mentioned before, you pay taxes when you withdraw from a Traditional IRA. There is an exception: when the amounts you deposited are nondeductible or you can prove were from post-tax monies, then you don’t pay taxes on that amount later when withdrawn.

For example, John is married and has a combined household income of $120,000. He files taxes married, jointly. He opens a Traditional IRA and puts in $5,000 for the year. Given his income level and the fact that the deposits were made from his net paycheck (after-tax) he gets no tax deduction on his income taxes for the IRA. However, later when he does withdraw, he will not pay taxes on base $5,000, only the interest earned on it. This sounds simple enough, but without proper documentation it gets hard to prove later on. Planning to avoid taxes this way requires long-term discipline in keeping income source documentation and deposit receipts to prove your case. It’s a lot easier just to put after-tax money in a Roth IRA and avoid this hassle.