Can you borrow from an IRA, 401(k) or Roth IRA to invest in a rental property or a business? — Bob H.
It can be tempting to borrow money from your retirement funds, but it's usually not a good idea, warns Frank deNapoli, senior vice president at Winslow, Evans & Crocker in Peabody, Mass. "You're shortchanging your retirement," he says.
Assets you take out of your nest egg will not have an opportunity to grow until you pay them back. That means you could be missing out on years of potential tax-deferred compound growth.
Most 401(k) plans allow loans, but borrowing is governed by strict rules. For example, you typically can't borrow more than $50,000 or 50% of the value of your 401(k). And you'll need to begin repaying that loan at your next pay period. If you're borrowing the money for most reasons, including to invest in a rental property or a business, you'll have up to five years to pay back the loan. (Loans to purchase a primary residence have longer payback periods, typically around 10 years.)
DeNapoli stresses that 401(k) loans should be an option of last resort. One reason: If you lose your job, you'll have to pay back the loan immediately or the IRS will treat it like an early distribution. That would trigger a 10% early withdrawal penalty in addition to income taxes.
As for IRAs, borrowing against them is prohibited except in self-directed IRAs. That type of account allows you to use your retirement assets as collateral for a loan on certain types of real estate. While this option poses fewer risks than borrowing from your 401(k), it's still dangerous: You're taking money out of your (presumably) diversified retirement portfolio to invest it in a single asset. "You're gambling your retirement assets on the real estate market," deNapoli says. "It could end in tears."
— Marc Mewshaw