401K to Rollover IRA

[taxxcpa]

A client changed jobs and rolled over her 401K minus $ 13,000 that she had borrowed from the plan which the 401K custodian kept to pay off the loan.

She got a sign-on bonus with the new job which enables her to place $13000 more into the rollover IRA than the net she received from the 401K.

Assuming that she had $113000 in the 401K and she had a direct rollover of $100,000. Then, using $ 13000 of her sign-on bonus she places $13000 in the new rollover IRA bringing it up to the total amount which would have been available if she had paid off the loan before making the rollover. (all done in a few days after leaving her old job)

I assume that she will get two 1099s--one for the direct rollover amount and a second one shown as a taxable withdrawal for the $ 13,000. Can she then identify the $ 13,000 as an indirect rollover?

If she had taken it all in cash without the direct rollover, she would have probably received one 1099 for the entire amount and could have identified it all as an indirect rollover. If she had paid of the loan before rolling it over, it could all have been identifed as a direct rollover. Therefore, I believe she can take it all as a nontaxable amount by the two-step approach she has taken. Am I right or wrong?

[FEDUKE404]

Bad choice

I'm not too sure that dog will hunt....

When she closed her prior 401(k), I'm sure internally she had $13k of taxable income and a rollover amount of only $100k. (Hopefully it was institution to institution transfer or any tax withholding could muck up things further!)

There is nothing left to roll over except the theoretical $100k...assuming that full amount was actually paid out to her.

The $13k "make up" money would then need to be considered as new funds into an IRA, with all of the usual IRS restrictions on such. Even IF it was possible for the employee to "break even" by somehow putting the other $13k into an IRA account (and thus negating the taxable $13k) I believe those funds could not be legally placed into the rollover account. You would have to check with the plan administrator on that.

BOTTOM LINE: I know times are tough, but generally speaking borrowing against your retirement account is on the most unwise financial decisions a person can ever make. It is quite possible that a person can end up netting (after federal tax/state tax/early withdrawal penalties) not much more than 50% of the amount withdrawn. I'm not even sure the mafia reaches those levels... (And don't get me started on "paying yourself" either.....in most/all plans whatever principal you withdraw no longer earns, tax free no less, any income!)

FE

[Kram BergGold]

I think I disagree

Let's assume a direrct transfer of 100k. So the 1099 will show total distributed of $113,000 and taxable $13,000. Why can't the TP make a $13k rollover deposit within 60 days? I can't think of any reason this won't fly.

[Roberts]

Let's assume a direrct transfer of 100k. So the 1099 will show total distributed of $113,000 and taxable $13,000. Why can't the TP make a $13k rollover deposit within 60 days? I can't think of any reason this won't fly.

What they SHOULD have done is paid the income tax on the $13k and repaid the loan as much as possible to avoid the penalty as much as possible. After leaving your job, you have 60 days to repay any loans. Why would they do a 401-k rollover so quickly?

The loan is considered a distribution for 60-day repay when the loan is taken out, not when they call it a loan loss.

[taxxcpa]

I agree she should have waited until she got the sign-on bonus before rolling it over, paid off the loan and rolled over the total as a direct rollover. Or, alternatively, paid off the loan, taken the money then put it in the rollover IRA--and when she got a 1099R with a code 1, show it as a rollover. All of this would achieve the desired result without question.

It may boil down to whether the Rollover custodian will accept the $ 13000 into the Rollover.

I tried creating a return for Adam Aardvark, a non-existent client, and showing, on a 1099R, $ 100,000 as a direct (code G) rollover and then entering a second 1099R with a code 1, and identifying it as a rollover. It shows up on the form 1040 as a single figure as $ 113000 with "rollover" printed on the 1040. So, at least, I got no error message from the tax software.

Of course, just because the software accepts it, doesn't prove it is OK.

[appelman]

As a practical matter...

If the IRA custodian will take the 13K, and I don't see why they shouldn't, I'd certainly be inclined to give it a try.

[RLymanC]

Code 1

I agree she should have waited until she got the sign-on bonus before rolling it over, paid off the loan and rolled over the total as a direct rollover. Or, alternatively, paid off the loan, taken the money then put it in the rollover IRA--and when she got a 1099R with a code 1, show it as a rollover. All of this would achieve the desired result without question.

It may boil down to whether the Rollover custodian will accept the $ 13000 into the Rollover.

I tried creating a return for Adam Aardvark, a non-existent client, and showing, on a 1099R, $ 100,000 as a direct (code G) rollover and then entering a second 1099R with a code 1, and identifying it as a rollover. It shows up on the form 1040 as a single figure as $ 113000 with "rollover" printed on the 1040. So, at least, I got no error message from the tax software.

Of course, just because the software accepts it, doesn't prove it is OK.

I have hasd some very sad results calling a Code 1 a rollover, IRS has, many times, required followup documentation proving the rolloever.

[Bees Knees]

If the $13,000 is paid to the new account within 60 days of the transaction, it is a rollover, regardless of whether the 1099R calls it code 1. No different than taking a distribution in cash, having 20% withheld for taxes, and making up the 20% with new money. (See TTB, page 13-22, second column, Kent's example)

[appelman]

Ca va sans dire!

It's their privilege. If you worried about it, you'd never file an indirect rollover.

[FEDUKE404]

Upon further review

While awkward, this might fly.

There are two major stumbling blocks:

1) Timing of distribution / rollover / appearance of new funds is critical.

2) I have some problem with the concept of rolling over $113k when in reality there was only $100k to rollover in the first place. Someone with much more knowledge than I would have to determine if there was a $113k "distribution" or a $100k "distribution" that could legally be rolled over. It might help to know what is going to be reported on the Form(s) 1099-R !

I think, if I were a mean ole IRS auditor, that I could make a reasonable case that there was (first!) to pay the loan a premature distribution from the account, followed by a rollover of whatever was left. If this was truly a direct (institution to institution) rollover, I think the most likely scenario is a Form 1099-R for $13k coded "1" and a second Form 1099-R for $100k coded "G." That might increase the challenge to the client to "make her case."

Perhaps there is a banker or plan administrator out there who could chime in?

And as taxxcpa noted, the simplest solution to this mess would have to pay off the loan prior to leaving the company.

FE

[Bees Knees]

2) I have some problem with the concept of rolling over $113k when in reality there was only $100k to rollover in the first place. Someone with much more knowledge than I would have to determine if there was a $113k "distribution" or a $100k "distribution" that could legally be rolled over. It might help to know what is going to be reported on the Form(s) 1099-R !

No problem in my mind. If there was a $13K loan against the 401(k), and the taxpayer left the job and chose to take a $100K cash distribution, closing out the account without re-paying the loan, then the 1099R is going to show a $113K distribution, even though the taxpayer only received $100K (not taking into consideration the fact that 20% would also be withheld for federal taxes).

If the 1099R shows $113 distribution, even though the taxpayer received far less in cash (due to loan and federal tax withheld), then $113 is eligible to be rolled over. There is NO rule anywhere that says the money used to make the rollover contribution has to be traced back to the distribution.

Anyone can take a distribution from an IRA, pension plan, etc., spend the money on anything they like, and then take new money from any source and roll it over into a new IRA, pension, or even back into the same one the original distribution came from. In fact, that is a cheap way to take or short term loan to purchase something. Take it from your IRA, buy what you want, and then make sure you re-pay it back into your IRA within 60 days. No tax, even if you use new money to fund the rollover.

If you need a citation for the above, look at Letter Ruling 9010007.

[Roberts]

Perhaps there is a banker or plan administrator out there who could chime in?

The IRS says you have 60 days from leaving a job to REPAY the loan. IMO, that's pretty clear how they expect things to be handled.

On a different issue:
When you take an early distribution from a 401-k, you can utilize the 60-day window for repay OR take a loan. You don't get both. That's why plan administrators start the 60-day window the day you take out the loan. Not the day they declare a loan as a taxable distribution. If you repay within 60 days you can avoid paying interest so they'll classify it a 60 day withdrawal / repay. If you go over 60 days, it stays a loan.

[taxxcpa]

Thanks, Bees Knees

Thanks, Bees Knees, I believe you have answered my question and supported your conclusion.
I was surprised that so many people seemed convinced that you could not roll over all eligible money just because you took part as a direct rollover and part which would be on a separate 1099R as a distribution which you could also roll over.

While I was concerned that there might be some unknown technicality, it seemed only logical that it would be eligible as long as there was no specific rule disallowing it.

[FEDUKE404]

Uncle uncle

So is there going to be a Form 1099-R for $13k coded "1" and a Form 1099-R for $100k coded "G," or a single Form 1099-R for $113k coded "G" ?

If the latter, please explain how that is possible.

Everyone keeps stating "transfer" (code "G") when it almost seems as if the actual facts would better support a $113k "premature distribution" (code "1") which, depending on whichever way the wind is blowing, was/is/will be properly placed within a new account to negate hopefully both the tax and penalty.

FE

[Burke]

The IRS says you have 60 days from leaving a job to REPAY the loan. IMO, that's pretty clear how they expect things to be handled.

On a different issue:
When you take an early distribution from a 401-k, you can utilize the 60-day window for repay OR take a loan. You don't get both. That's why plan administrators start the 60-day window the day you take out the loan. Not the day they declare a loan as a taxable distribution. If you repay within 60 days you can avoid paying interest so they'll classify it a 60 day withdrawal / repay. If you go over 60 days, it stays a loan.

I hate to throw muddy water on the general conclusion of most posters that it does qualify as a rollover, but I have to agree with Roberts. The loan was taken out (I am assuming) way prior to the employment termination, and it became a deemed distribution when not paid back into the original 401k plan by the deadline. I do not believe that part qualifies for rollover treatment. Will try to research further.