It’s one of the most common questions in all of personal finance: should you loan money to family members? The possibility of having a family member owe you money can be an unpleasant one, but in dire situations, it may be all that a family member can rely on. And because private lending is an option for investing in a Self-Directed IRA, it’s not unreasonable to wonder if this is something a retirement investor can do with the money they have set aside for retirement.
Is It a Good Idea to Loan Money to Family Members?
There are two questions here: first, is it a good idea to loan money to family members? And if so, should an investor do that with money in an IRA?
Loaning money to family members can be fraught with all sorts of risk. Beyond the possibility that you will lose your money because the family is unable to pay it, there’s always the personal risk—the idea that you might one day be forced to ask for repayment, and that these issues can then cause your family members to avoid you in the future.
For that reason, many financial experts recommend looking at a request for money as not a loan, but a possibility of giving someone a gift. Giving someone a monetary gift has certain tax implications, for example, and it’s important that you make this distinction.
But when it comes to the source of the funding, there’s one thing you should know: why you need to avoid using funds from a Self-Directed IRA.
What About Private Lending in a Self-Directed IRA?
If you are not familiar with the terms of a Self-Directed IRA, it might seem tempting to use retirement funds to help someone in your family during a time of need. After all—those are retirement funds, are not they? They are long-term funds that you do not need right now. You figure: if they will not help you right away, they might as well help someone in your family who needs them, right?
The answer is simple: Never use money in a Self-Directed IRA to loan to family members.
This money is off-limits for multiple reasons:
- Taxes and fees. Taking money out of a Self-Directed IRA—or any retirement account, for that matter—before its time will result in penalties and fees that make the cost of that money far too heavy. You will essentially be paying massive interest rates just to use your own money.
- Prohibited transactions. When you use private lending in a Self-Directed IRA, you cannot use those funds to transact with “disqualified persons” such as family members. This is one of the central rules of working with a Self-Directed IRA.
- Retirement money is off-limits. Even forgetting about the prohibitions and tax penalties, one thing is clear: retirement money is for retirement! You should feel no obligation to give out this money just because it’s sitting there. The money’s job is to grow over the long-term, helping you fund retirement, and you are under no obligation to send it out to family members.
It’s clear that any investor—not just someone with a Self-Directed IRA—needs to set clear boundaries between personal investments and retirement investments. The same is true when it comes to giving money to family. With the appropriate knowledge, you will be able to explain why you cannot touch the money in a Self-Directed IRA: not only would it be against the rules, but it would be a bad idea for everyone involved.