Clients sometimes need cash temporarily and view their Individual Retirement Accounts (IRAs) as the perfect source. This can be a dangerous option unless they follow the 60-day rollover rule. Your client can borrow money from an IRA without paying tax as long as it’s paid back within 60 days. This resource can be a lifesaver when needed but there are two important caveats. They can only do this kind of transaction once every 12 months and they MUST repay the money within 60 days.
Missing the 60 days or simply keeping the money can be expensive: The withdrawal would be subject to ordinary income tax plus a penalty tax of 10 percent if the IRA holder is under age 59-1/2. (This is just Federal tax. The state can also impose tax and penalty.) Considering Federal and state taxes as well as penalties, the total hit could amount to 50 percent or more!
Up until recently, the 60 day rule was black and white. There was no way the IRS would allow tax free status if the deadline was missed – no matter the excuse or how close the payback was to 60 days. Having to pay unplanned taxes on a distribution could wipe out the IRA – since taking the tax money out of the IRA would also be subject to tax!
Now, the IRS is moving away from black and white. In Revenue Procedure 2016-47 (dated August 24, 2016), the IRS will waive the dire tax consequences of missing the 60 day deadline for “reasonable cause.” Acceptable reasons include:
Additionally, to qualify for reasonable cause, the IRA repayment must be made as soon as possible after the late payment was discovered. Thirty days after discovery is automatically acceptable by the IRS.
Although it is possible to get a waiver for repaying an IRA loan after 60 days, it is best that clients carefully follow the rules. By doing so, they have the opportunity to give themselves an easy temporary loan when they need it.