Do I Automatically Have to Pay the IRS if I Borrow From My IRA?

Loans from IRA accounts are prohibited

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While you can generally borrow from a 401(k) account or other employer-sponsored retirement plan, individual retirement accounts are restricted from making loans. The IRS has strict policies concerning how it treats any attempt to borrow money from an IRA. Even with these restrictions, you can use your IRA to take a short-term loan, without having to pay taxes or penalties on the amount borrowed, as long as you follow the rules carefully.

Traditional IRA

The IRS considers money that you borrow from a traditional IRA account a taxable distribution. This means that you must pay taxes on the loan proceeds at your income tax rate. If you are under age 59 1/2, you will also owe a 10 percent tax penalty on the money that you borrowed, unless it qualifies for an exemption. The taxes on this loan will be due for the tax year that you took the disbursement. If you pledge your traditional IRA account as collateral for a loan, the IRS considers the entire balance of the account a distribution, and you will owe income tax and any applicable penalties on the balance of the IRA.

Roth IRA

While the loan rules are the same for a Roth IRA, the money in the account is treated differently from a tax point of view. While a loan from a Roth IRA is still treated as a distribution, Roth IRA contributions are made after taxes. Since the taxes have already been paid on Roth contributions, you can withdraw contributions from your Roth IRA tax-free. Any investment gains may be subject to income tax and applicable penalties as well, particularly if the account has been open less than five years.

No Repayment

Since the IRS treats any loan arrangement from your IRA as a disbursement, you cannot repay the money that you withdraw. In addition to paying taxes on your withdrawal, you cannot replace the money that you withdrew. You will lose the effects of tax-free or tax-deferred compounding on these funds.

Tax-Free Rollover

There is one exception to the no-loan policy for IRAs. You can take a short-term loan from your IRA by utilizing the tax-free rollover provisions. If you take a cash withdrawal from your IRA and replace the money within 60 days, you will not incur any taxes or fees. You need to redeposit the money into any IRA of the same type, traditional or Roth, within 60 days -- it does not have to be the same account.

Restrictions on Tax-Free Rollover

You can only complete one tax-free rollover on an IRA per one-year period. This one year applies to any IRA impacted by the rollover. A second attempt at a tax-free rollover is automatically considered a withdrawal. You cannot replace the money and must pay taxes if due. If you take $10,000 from IRA 1 and deposit the money into IRA 2 in 59 days, you cannot take advantage of the tax-free rollover using IRA 1 or 2 for one year from the date you withdrew the funds from IRA 1. You may do a tax-free rollover from IRA 3, but you could not deposit funds into IRA 1 or 2.