Loan Offset Strategy - Roth to Traditional

Forum|Forum|4 years ago
September 9, 2021
1 reply
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Hello!

I have a somewhat straightforward question, and I am hoping someone can confirm that my strategy is allowable and, if not, help me understand why.

Earlier this year, I left a job with a 401k loan (for example's sake, I'll say $10k). I then rolled over my 401k balances into both a Roth IRA and a Traditional Rollover IRA. The loan was taken entirely out of my pretax balance in the 401k. The 401k was open for six years if that matters (I don't think it does?). I'm not at retirement age.

I do understand that I could just pay off the offset into the Traditional IRA with money from another source, but I would prefer not to do this.

I currently have enough contributions (and the paperwork to back it up) in my Roth balance to cover the loan. Is it allowable to take a withdrawal from my Roth IRA (from the contributions), moving it to the Traditional Rollover IRA, as a way to pay the offset? Does this save me from paying taxes/penalties now (I recognize that I am moving post-tax money into a pre-tax account and will have to pay tax again later)?

Thanks for the help.

Best answer by Opus 17

Yes, as long as you actually withdraw the money from the Roth IRA (take a distribution) and don't try and do a rollover or direct transfer.

If you take a withdrawal, and follow all the usual rules for withdrawals, then once the money is in your bank account, it becomes the same as all your other money and you can do anything you want with it, including putting the money into the pre-tax IRA to offset the loan amount. (Note that this is not a "contribution" to the IRA and should not be done in the normal way. It's technically a special type of rollover from the 401k to the IRA, and the IRA trustee should require special paperwork to process this.)

Opus 17

Answer

Level 15

Yes, as long as you actually withdraw the money from the Roth IRA (take a distribution) and don't try and do a rollover or direct transfer.

MikeinSC

Level 5

Seems like the money needs to be put in the 401k and then rolled to the IRA. My understanding is that if you roll from a 401k to an IRA and have an outstanding loan, they require repayment or it will be a distribution. I did not think you could fix this by putting money in an IRA since IRA's cannot have loans.

I would contact the plan administrator for the 401k.

Opus 17

Level 15

@MikeinSC

There was a recent law change, I believe it was the SECURE act. When an employee separates from service and they have an outstanding loan in their qualified retirement plan, they have 60 days to repay the original plan. If they don’t, the plan will call it a deemed distribution and issue a 1099R at the end of the year. However, under the SECURE act, the employee has until the tax filing deadline to make an offset contribution into a different plan that will offset the loan and cancel it out. This can be viewed as a special kind of delayed rollover. The taxpayer will still report the 1099R on their tax return, but when TurboTax asks what did you do with the money, the taxpayer will be able to indicate that they made an offset contribution to a different retirement plan. (In most cases, the original plan will refuse to accept a loan repayment after 60 days.)