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matthewareilly
Level 1

Loan Offset Strategy - Roth to Traditional

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.

2 Best answer

Accepted Solutions
Opus 17
Level 15

Loan Offset Strategy - Roth to Traditional

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.)

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*

View solution in original post

Opus 17
Level 15

Loan Offset Strategy - Roth to Traditional

@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.)

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*

View solution in original post

7 Replies
Opus 17
Level 15

Loan Offset Strategy - Roth to Traditional

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.)

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
MikeinSC
Level 4

Loan Offset Strategy - Roth to Traditional

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

Loan Offset Strategy - Roth to Traditional

@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.)

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
MikeinSC
Level 4

Loan Offset Strategy - Roth to Traditional

Thanks.  Need to "bone up" on that act.  Appreciate it!!!

macuser_22
Level 15

Loan Offset Strategy - Roth to Traditional

If it applies to you then your 1099-R should have a code "M"  in box 7 (there could also be a second code).     If it had a code "L" then the issuer said the offset was prior to separation from service.

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**
macuser_22
Level 15

Loan Offset Strategy - Roth to Traditional


@MikeinSC wrote:

Thanks.  Need to "bone up" on that act.  Appreciate it!!!


You can get all the information you need from the IRS 1099-R instructions and Pub 590B.

 

https://www.irs.gov/instructions/i1099r

 

Plan loan offsets.

If a participant's accrued benefit is reduced (offset) to repay a loan, the amount of the account balance that is offset against the loan is an actual distribution. Report it as you would any other actual distribution. Do not enter Code L in box 7.

A qualified plan loan offset is a type of plan loan offset that meets certain requirements. In order to be a qualified plan loan offset, the loan, at the time of the offset, must be a loan in good standing and the offset must be solely by reason of (1) the termination of the qualified employer plan, or (2) the failure to meet the repayment terms because the employee had a severance from employment. Report a qualified plan loan offset as you would any other actual distribution. In addition, enter Code M in box 7.

 

https://www.irs.gov/publications/p590b

 

Qualified plan loan offsets. A qualified plan loan offset is a type of plan loan offset that meets certain requirements. In order to be a qualified plan loan offset, the loan, at the time of the offset, must be a loan in good standing and the offset must be solely by reason of (1) the termination of the qualified employer plan, or (2) the failure to meet the repayment terms is because the employee has a severance from employment. If you meet the requirements of a qualified plan loan offset, you have until the due date, including extensions, to file your tax return for the tax year in which the offset occurs to roll over the qualified plan loan offset amount.This revision is effective for tax years beginning January 1, 2018.

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**
matthewareilly
Level 1

Loan Offset Strategy - Roth to Traditional

Thank you all for the help on this. Much appreciated,

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