Can an IRA be pledged as a security instrument?
I have offered to a friend that has recently gone through bankruptcy to be his bank for acquiring a new house. If he were to get an existing home it would be the security for the loan. Unfortunately, his wife is only interested in building a new home so during construction there would not be much more than dirt, sticks and bricks as security so he has offered to pledge his IRA as security during the construction phase. Can this be done such that I could get his IRA dollars in the event something happens to him during the construction?
Permalink Submitted by William Tuttle on Thu, 2010-08-26 00:29
Using an IRA as collateral for a loan is a “prohibited transaction” and will result in the amount being deemed distributed and subject to all taxes and penalties.
Permalink Submitted by joe fotz on Thu, 2010-08-26 01:01
Would the act of signing a document be the triggering event that would be a prohibited transaction or would it be triggered by an attempt to collect? My friend knows that in order for me to be able to claim his IRA dollars he would owe the taxes and penalties so in the event that this were to take place and the taxes and penalties were paid, would the account value be usable by my friend to pay me or would they be forfeited for having pledged them? Would they be attachable by me or would I have to chase his distributed dollars just as any other asset he may have?
Permalink Submitted by Alan Spross on Thu, 2010-08-26 02:55
Yes, the execution of the document would constitute the prohibited transaction. Per 408(e)4 copied below, the portion of the IRA that was pledged is deemed distributed as of the first of the year subject to tax and early withdrawal penalty:
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4029e)(4) Effect of pledging account as security
If, during any taxable year of the individual for whose benefit an individual retirement account is established, that individual uses the account or any portion thereof as security for a loan, the portion so used is treated as distributed to that individual.
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I doubt that the distribution would impair your rights to collect the assets so distributed, but this question is out of my area.