So you’ve finally had enough of the hype and are determined to score a pair of tickets to see “Hamilton” for Lin-Manuel Miranda’s final performance as the lead. Tickets selling through ticket brokering sites are going for outrageous prices, and you’re a bit short on cash. Should you embark on a personal revolution and loot your retirement accounts to go?
In a recent article, we addressed the exceptions to the early withdrawal penalty on IRA distributions taken prior to an individual reaching age 59 1/2. In such a case, the IRA distribution would still be subject to federal income tax and, potentially, state income tax, and would result in permanently removing those assets from the IRA, having a negative impact on the availability of future retirement income. 
So, if you need a quick cash infusion and do not want to suffer the income tax ramification of an IRA distribution, what can you do? One option would be to take a loan from your retirement account. While an advisor may not typically recommend that an account owner borrow from their retirement account, a loan from one’s retirement can have both benefits and costs, as discussed below:
Reasons to take a plan loan:
- Easy to obtain
- Credit through traditional lines are either unobtainable or fully used
- No early withdrawal penalties from an early distribution
- Pay interest to one’s self, rather than to a lender
Reasons not to take a plan loan:
- Retirement plan account balance is diminished if the loan is not paid back
- Harsh penalties and federal income tax will apply to the balance of the loan that is not paid back in full
How much can you borrow from your retirement account? One can take a loan up to the lesser of $50,000 or 50% of the plan assets
In addition, the loan must be made from a qualified retirement account, which does not include traditional IRA’s, Roth IRA’s, SEPs, or Simple IRA’s. By taking a loan from these types of retirement accounts, you would effectively trigger a distribution subject to federal income tax and, potentially the early withdrawal penalty.
Now that you know the basics of plan loans, let’s address the question of deductibility of the interest paid on that loan. Generally, the primary way to determine if interest paid on a loan is deductible is to determine what the borrowed funds were used for. This generally applies to loans from qualified plan loans, other than from 401(k) or 403(b) plan accounts.
Thinking in terms of the use-of-funds concept, looking at personal interest expense, if the funds are either used to acquire a qualified residence or to pay qualified higher education expenses, the interest paid on qualifying loans is generally deductible. Otherwise, interested paid for other personal-use purposes is generally nondeductible. If loan proceeds are used in the taxpayers business, then the interest paid is a generally a qualified business expense.
If loan proceeds are used for making investments, then the interest is typically deductible up as investment interest to the extent of the taxpayer’s net investment income. However, as mentioned earlier, interest paid on loans taken from 401(k) and 403(b) plans is almost NEVER deductible, regardless of what the funds were actually used for.
As you can see, the tax treatment of loans from retirement plan accounts and their related interest expense are a veritable minefield that should never be navigated without expert guidance! If you have any questions about loans from retirement plans, please contact us at info@zinnerco.com or contact us at professionals at Zinner & Co. LLP at 216-831-0733. We're ready to start the conversation.
