I Need a Loan. Can I Borrow From My IRA?

It's important to maintain a solid emergency fund so you have cash reserves to tap when unplanned expenses come your way. But sometimes, things happen, and the need to borrow money in a pinch may arise. And in that case, you may be thinking of taking out a loan against your retirement savings.

If you have your savings in an IRA, though, you're out of luck in that regard. That's because IRAs do not allow savers to take out loans against their balances. If you need to tap your IRA before age 59 ½, any money you remove will be considered an early withdrawal -- one that's subject to a 10% penalty.

Now if you have your retirement savings in a 401(k), your plan might allow you to take out a loan against your balance. But doing so could turn out to be a costly mistake.

Don't borrow against or tap your retirement savings

When you take out a 401(k) loan, there's always the risk of not managing to pay that sum back. And that could end up being costly, because a 401(k) loan that isn't repaid on time is treated as a withdrawal. If you're not yet 59 ½, you'll be subject to the same 10% penalty that applies to early withdrawals from an IRA.

Now you may be inclined to just tap either retirement account if your need for money is pressing and just deal with the penalty. But keep in mind that it's not just losing 10% of your withdrawal you need to worry about. You also have to factor in lost growth on the sum you remove.

Let's say you take a $5,000 withdrawal from your IRA at age 30 to cover an unplanned bill. In that case, you'll lose $500 right off the bat to the aforementioned penalty.

But let's also say your IRA is invested heavily in stocks, and as such, your account generates an average annual 10% return before inflation, which is consistent with the stock market's average, as measured by the performance of the S&P 500. If you don't retire until age 65, it means that by losing out on 35 years of gains on your $5,000, you'll short yourself around $140,000 in retirement income. That's a much bigger deal than a $500 early withdrawal penalty.

Find another way to borrow

Borrowing from an IRA isn't an option, and clearly, taking an early withdrawal isn't a great one, either. So if you have to borrow money, look into different options for doing so affordably. 

One option may be to take out a personal loan, which allows you to borrow money for any purpose. If you own a house, you can also borrow against the home equity you have in it. You may also be able to approach a family member for a loan if you're comfortable doing so.

It's not so unusual to wind up in a financial jam, to the point where you need to borrow money ASAP. But don't turn to your retirement savings to get that money. Doing so is a move you might sorely regret in the long run.