A client needed about $50,000 for an emergency expense. He was in a bind and didn’t have much in his checking or savings account. His only option, or so he thought, was to tap into his IRA.
There are a lot of drawbacks to using IRA funds before retirement:
- If taken out early, the client would be subject to income tax (maybe 20%) plus a 10% IRS penalty. A $50,000 withdrawal would trigger $15,000 in taxes and penalties. The client would end up with only $35,000 after taxes.
- There are very few hardship distributions allowed in an IRA.
- There is almost no way to put the money back into the IRA after it has been taken out.
As a solution, we would advise the client to look to their 401(k) with their employer. Specifically we would advise the client to borrow money from their 401(k). With this arrangement it does not trigger income taxes and there’s no penalty, but it has to be repaid in 5 years and the client has to pay interest, in addition to many other restrictions.
We almost always advise against taking retirement money in any way (including borrowing from a 401(k)). But if the client is in a real tough bind, this would be the only sensible option.