By: Clay Wyatt
Maybe you've lost your job and are getting behind on your bills. Maybe you had an unexpected medical procedure that your insurance offered little to no coverage for. Whatever the case may be, that wad of cash that you have invested into your IRA may seem like a tempting way to bail yourself out. Are you considering using your IRA to pay off urgent expenses? Let's examine the pros and cons of doing so and the IRA tax ramifications.
The obvious pro to using your IRA to pay off urgent expenses is that you'll keep creditors from blowing up your phone. You won't have to deal with constant calls and letters asking when you're going to pay up and the rude collectors who initiate them. They could also eventually sue you, so you can prevent the case from going to court if you use your IRA to pay off your expenses. That will help keep your stress level down during this difficult time.
Another major benefit to using your IRA to pay off urgent expenses is that your credit report won't be sunk if you are able to use your IRA to pay off your urgent expenses. That $15,000 that you owe for your medical procedure will eventually end up on your credit report if you don't pay it off within a few months. That will lead to difficulty in obtaining future credit and will make borrowing more expensive for you down the line.
The treatment of your withdrawal may also be a pro when using your IRA to pay off urgent expenses in the sense that penalties can be avoided. If you are using it to pay off medical expenses in excess of 7.5 percent of your adjusted gross income, it may be done IRA penalty-free. The same situation applies if you are using it to pay for health insurance premiums after you have been unemployed for 12 weeks or longer. Additionally, if you are disabled and can prove that you are incapable of working, you can use your IRA to pay for expenses during this time.
When using your IRA to pay off urgent expenses, you may end up paying IRA penalties on your withdrawals (if under age 59 1/2). While there are some ways to withdraw funds from your IRA without incurring penalties, such as those listed above, this won't always be the case and that means IRA tax as well as penalties. For example, paying off a balance on your car loan may be an urgent expense to avoid a repossession, but the IRS will still levy a penalty on you if you tap into your IRA to do so.
Another downside to using your IRA to pay off urgent expenses is that you won't accumulate interest on the money that you withdraw. Let's say that you take $10,000 out to pay for medical expenses that are in excess of 7.5 percent of your adjusted gross income. You won't be hit with penalties on that amount, but you'll forfeit any interest that would have been earned on that money. This could end up being a good situation if the stock market plummets during that time, but you'll still have $10,000 less in your account when it comes time to retire. If the stock market surges during that time, then you'll lose out on those gains, as well.
And of course, there is the IRA tax on the withdrawals. So it is quite possible that the federal and state tax could exceed 30%, add another 10% for penalties and you only have 60% left for urgent expenses. Maybe it's better to consider an IRA loan.
Explore alternate resources before you use IRA to pay bills. A bank loan or money that you may have sitting in non-retirement accounts may work out much better for you. Using your IRA to pay off urgent expenses should be a last resort.
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