On Feb. 14, Money Under 30 ran my column about the five (and only five) times it might be OK to tap a retirement account. Little did I know at the time that I’d soon put one of those scenarios to the test.
In that column, I interviewed Eleanor Blayney, the consumer advocate for the Certified Financial Planner (CFP) Board of Standards. And while Blayney, like many a financial pro, frowns on tapping a retirement account in general, she did talk about the 60-day liquidity squeeze.
That is: If you can pay funds back to your retirement account within 60 days, you can tap them without any penalty. But the key here is that 60-day window. Blow it, and you’ll face heavy tax consequences.
That’s exactly the situation I faced in the weeks following that column: a liquidity squeeze. As a veteran staff writer at the Chicago Tribune, I received paychecks every two weeks via direct deposit. My bill paying was automated, too, so I rarely worried about where the money came from, or when.
But in 2009 massive layoffs took me out, along with more than 50 other colleagues. And four years later, the adjustment to the freelance life remains a rough one in this aspect: Some clients pay you right away (thanks to my Money Under 30 homies), and others take their sweet time. And so I never, ever know exactly when the cash will land in my bank account.
So in May, I found that I had much less money on hand than I needed to pay my mortgage and bills. Blayney talks about how an emergency fund is the real backstop here, but she’s also smart enough to know that for some of us, that’s a pipe dream. I’ll explain in a bit why an emergency fund in my line of work proves so difficult — but first, here’s how an IRA tap works.
Let’s review the basics for those of you new to the retirement fund game. There’s a difference between a 401(k) and an individual retirement account (or IRA). Simply put, a 401(k) is offered through your place of work and involves your contributions (often matched or supplemented by your employer). An IRA is a private investment funded solely by your own money. And often, it’s harder to tap a 401(k) than an IRA, but you can take a 5-year loan from many 401(k) plans, so long as you pay it back on time.
With IRAs, though, it’s a different story. You can access money for a 60-day period with what is considered a tax-free rollover. But guess what happens if you don’t pay it back? You get to pay the Internal Revenue Service, and big.
We’ll speak next week with Carrie Schwab-Pomerantz of Charles Schwab, who outlines the rules of the IRA loan game this way: “The IRS is very particular about timing — 60 days is the absolute limit and it starts on the day you receive your money, no exceptions. If you don’t put the money back into an IRA within that time period, it’s treated as an ordinary withdrawal subject to regular income taxes and a 10 percent penalty if you’re under age 59½. Plus, you lose the chance to put the money back.”
Yet there I stood, $3,000 in the hole and with no other place to turn for dough. On May 12, I took the money from my Citibank IRA — a bit like a savings withdrawal, but with lots more paperwork — then marked July 12 on my iCal. That was the 60-day mark, and the deadline for returning the funds to my IRA without tax penalty.
The cash provided me with just the short-term shot in the arm I needed. In January, I’d lost 90 percent of my work from one of my biggest writing clients; by July 1, I was back on an even keel. I made enough money to pay my bills, meet my quarterly taxes, chip away at credit card debt and put some money in reserve for the IRA loan payback.
Still, it was close. I visited a Citibank branch on July 12 — deadline day — and repaid in full by partially tapping a credit line. (A week later, I repaid the credit line.) What’s more, it took a full hour for the personal banker to call into Citibank’s headquarters and make sure the $3,000 was properly credited back to my IRA. Waiting for that call to end successfully felt like waiting for test results from a doctor.
In a word: Phew.
Insofar as borrowing from my IRA, that’s it for me — for 2013, anyway. You can only use a tax-free rollover in a specific IRA once within a 12-month period, beginning on the date you receive your money. But you may wonder: Why do it in the first place? The answer, in my case, is simple: Freelance writing is risky business. No two clients pay alike, either in scale or timeliness.
As of press time I’m owed more than $10,000 by various outlets. At least 25 percent of that amount is late by more than month. It takes a strong stomach and great credit lines to go the freelance route. On the very day I write this, I’m making half my mortgage payment via credit line until one of my clients catches up to the $3,000-plus they owe me.
Regretfully, I’m also my own collection agency. I’ve been chasing down at least three payments for so long, I’m tempted to resort to threats — but how do you threaten the hand that feeds you? Most of the time, you can’t. (Funny how these same people always need the work done “as soon as possible.”)
I wish I didn’t have to borrow on my IRA, and the good news is that I’ve actually recovered enough financial footing to make $200 a month in new contributions, compared to squat about a year ago. I hope you’ve come to believe, as I do, that your retirement account is one source of true wealth, created by the magic of compound interest over time. If you’re growing and nurturing that nest egg, good for you: You can’t imagine how it will pay off when you turn 60 (though you can calculate it here).
But if you have to borrow from your IRA, remember: Don’t roll the dice. While it can be an effective alternative to high-interest credit cards or other unsecured debt, it can also cost dearly if you don’t pay the money back within the allotted 60 days. Your decision to borrow from an IRA should be based only on a sensible, calculated risk. I was reasonably certain I could pay the money back in 60 days, and I did … though if there is a next time, I don’t plan to go down to the wire.
Is it possible to take early withdrawals from an IRA, pay the taxes and penalties, and still come out ahead? That’s a question I hope to explore in a future column.
In the meantime I default to experts like Blayney, who don’t recommend it for anyone in their mid-30s or under, unless it’s a financial calamity or life-threatening emergency.