Have you ever considered borrowingmoney from your IRA?Technically, the law doesn'tallow you to borrow money from yourIRA, but people have found a wayaround the law. Here's how they do it.The law permits you to rollover your IRAaccount from one custodian to another.Note: You are only allowed one rolloverevery 12 months. When you do rolloveryour IRA, your current custodian willsend the proceeds directly to you. Then,you will deposit the proceeds with thenew custodian. You have 60 days to dothis. So, in effect, these funds constitutea tax-free loan for that 60-day period.
Truth and Consequences
Many people have used this strategyto raise funds for overdue bills and livingexpenses. However, there is a problem ifyou fail to redeposit the funds within therequired 60-day period. There is no graceperiod and, based on a recent PrivateLetter Ruling by the IRS, rarely anyexceptions to this rule. In the case thatresulted in the Private Letter Ruling, thetaxpayer had lost his job and tapped hisIRA to pay for living expenses and bills.He then tried to repay the borrowedfunds once he found employment.
Unfortunately for this taxpayer, the 60-day period had expired and the IRS rejectedhis request, sending a clear signal to alltaxpayers of the perils of using this strategy.The truth is the penalties for failing torepay funds into your IRA within the 60-day period are harsh. The funds are treatedas a withdrawal and, as such, are subjectto ordinary income taxes in the yearwithdrawn. In addition, if you areyounger than age 59 1/2 at the time of yourwithdrawal, you will be subject to a 10%federal early withdrawal penalty as well.
The IRS has granted waivers to taxpayersin the past, but only underextreme circumstances. These circumstancesinclude cases where the taxpayerwas mentally ill, had Alzheimer's disease,or there were mistakes made on the partof the custodian. Essentially, waiverswere granted when circumstances werebeyond the taxpayer's control.
Based on the stern position of the IRS,I advise clients to do a direct transferinstead of a rollover when moving IRAfunds from one custodian to another.This is sometimes referred to as atrustee-to-trustee transfer. With a directtransfer, your new custodian will haveyour funds electronically wire-transferredfrom your old custodian into yournew IRA account. When you choose todirectly transfer your account, there is nopossibility of getting caught in the 60-day rule trap, which can be a costly andirreversible mistake.
Stewart H. Welch III, CFP®, AEP,founder of The Welch Group, hasbeen rated one of the nation's topfinancial advisors by Money andWorth. He is the coauthor of J.K.Lasser's New Rules for Estate andTax Planning (John Wiley & Sons, Inc; 2002). Hewelcomes questions or comments from readers at800-709-7100 or www.welchgroup.com. Thisarticle was reprinted with permission from theBirmingham Post Herald.