A Roth individual retirement arrangement is a type of retirement account that allows your investment earnings to grow tax free until you're ready to use them for retirement. You can't directly borrow from a Roth IRA, but you can remove money without penalty for up to 60 days under rollover rules provided you put the money back into the same Roth IRA or another such account. You can also withdraw earnings penalty free for certain expenses, including first-time home purchases and some medical costs.
How a Roth IRA Works
A Roth IRA is a type of retirement account. You can open one with a bank, brokerage or other financial institution of your choice. Each year, you may deposit up to $5,500 into your Roth and traditional IRA accounts. You can deposit up to $6,500 if you're at least 50 years old. In either case, you can't deposit more than you've earned that year, even if you have the money in your savings.
You pay tax as normal on money you earn and put into a Roth IRA. However, when you withdraw money from a Roth IRA after the retirement age of 59 ½, you do not pay tax on any of it, including investment earnings that have accrued in the account over time. This allows your investments to grow without tax, so it can be a good opportunity if you expect to see lots of investment earnings or expect to be in a high tax bracket when you withdraw funds from the account.
You can generally withdraw money you put into a Roth IRA without paying additional tax, but if you withdraw investment earnings before you are 59 ½, you will generally owe income tax on the earnings. You will also owe a 10 percent penalty to the IRS beyond your normal income tax. Some exceptions do apply.
Comparing Traditional IRAs
In addition to Roth IRAs, there is a separate kind of retirement account called a traditional IRA. Like a Roth IRA, you can set up a traditional IRA for yourself with a financial institution of your choice. You can open more than one of each type of account, and some people maintain more than one to take advantage of deals or funds available through different institutions.
With a traditional IRA, you can deduct money you contribute to the account from your federal income taxes. States have different policies on how to handle IRAs. When you withdraw money after the retirement age of 59 ½, you pay tax on whatever you withdraw at your ordinary income rate. You're essentially deferring tax on your investment principal and earnings until you retire, and this can be a good deal if you'll likely be in the same or a lower tax-rate bracket when you retire. Early withdrawals are subject to income tax plus an additional 10 percent penalty, unless exceptions apply.
The contribution limit of $5,500 or $6,500, depending on your age, applies across all of your traditional IRA and Roth IRA accounts. There are also separate types of IRAs called SEP IRAs and SIMPLE IRAs. These are opened for you as part of an employer-sponsored retirement program, and they have their own contribution rules, though they behave like traditional IRAs when it comes to withdrawals and paying taxes.
Loan Against a Roth IRA
You technically can't borrow from a Roth IRA or a traditional IRA or use the funds as collateral for a loan. You are allowed to take money from a Roth or traditional IRA and deposit it back in the same account or into another account within 60 days. This falls under the IRS rollover rules, which are generally designed for moving money from one account to another, such as if you change IRA providers.
If you fail to return Roth IRA earnings or traditional IRA funds in time, you can get hit with the 10 percent tax penalty on early withdrawals, so it's best to use this strategy only if you have a short-term cash crunch that you know will be resolved within a couple of months. You're also generally limited to one rollover per year.
Remember that you can also take your contributions out of a Roth IRA at any time with no penalty, though you'll be hit by the annual contribution limit if you want to put them back after the rollover period. Legally, when you take money out of an IRA, you draw down your initial contributions first, then money converted from another type of retirement account and finally your earnings.
Borrowing Against a 401(k)
If you have a 401(k) or 403(b) retirement account from an employer, you may be able to borrow against that. You generally can't borrow more than $50,000 from a 401(k), and if you have more than $20,000 in the account, you're generally limited to borrowing 50 percent of what's in the account.
Loans are generally limited to five years under IRS rules, though they can be longer if used to buy a house. Talk to your plan provider to learn the details of what's possible through your plan and what interest rates would look like. If you fail to pay back a 401(k) loan, it's generally taxable as a distribution from the plan. You can't borrow against a SEP IRA or SIMPLE IRA.
Roth IRA Withdrawal for House
If you're a first-time homebuyer, you can withdraw funds from your traditional or Roth IRA to buy a house without paying a penalty. You can withdraw up to $10,000 for this purpose.
If it's a Roth IRA and you've had money in the account for at least five years, you can withdraw both contributions and up to $10,000 in earnings from it without tax or penalty. If it's been less than five years, you can take contributions with no tax or penalty and up to $10,000 in earnings with no 10 percent penalty, but you must pay ordinary income tax on the earnings. If it's a traditional IRA, you can withdraw up to $10,000 without penalty, but you'll have to pay income tax on the money you take out at your usual rate.
Whether it's worth taking a Roth IRA home purchase withdrawal depends on a number of factors, including interest rates, your retirement needs, your housing needs and your expected investment earnings. You may wish to consider other options to borrow the funds.
Other Early Withdrawals
There are other circumstances where you can withdraw earnings early from a Roth IRA or funds from a traditional IRA without a tax penalty. Generally, with a traditional IRA you'll owe income tax, and with a Roth IRA you'll owe tax on earnings withdrawn before age 59 ½ if you've had the account less than five years.
You can often withdraw funds early if you're in the military reserves or National Guard and are called for active duty. You can also do so without penalty to pay for medical expenses above 7.5 percent of your IRS adjusted gross income or to pay for health insurance while you're unemployed. If you're disabled, you can often withdraw earnings or traditional IRA funds without penalty. You can also do so to pay for certain educational expenses for yourself and your family.
- Charles Schwab: Roth IRA Withdrawal Rules
- IRS: Publication 590-B (2017), Distributions from Individual Retirement Arrangements (IRAs)
- IRS: Publication 590-A (2017), Contributions to Individual Retirement Arrangements (IRAs)
- IRS: IRA FAQs – Rollovers and Roth Conversions
- Marketwatch: How to Borrow Money from a Roth IRA
- Investopedia: How Can You Borrow from a Roth IRA?
- Investopedia: Can You Use Your IRA to Buy a House?
- NerdWallet: Should You Use Your Roth IRA to Buy a Home?
- IRS: Retirement Plans FAQs Regarding Loans
- If you return the money you withdrew from your IRA within 60 days, you won't have to pay taxes on it. However, you will still have to report the distribution to the IRS. Use either IRS form 1040 or 1040A to report it.
- You can only take a rollover distribution once in a 12-month period. If you need to take a temporary loan from your IRA sooner than that, you will need another source of cash.
- Don't miss the deadline for depositing the funds you withdrew into an IRA. If you fail to make the deadline, your withdrawal will count as a distribution and you will face taxes and penalties.
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.