401K to Rollover IRA

[New York Enrolled Agent]

The deemed distribution that does not qualify for rollover treatment in your linked article is talking about when the loan no longer qualifies for the distribution exception, such as when the loan balance exceeds $50,000, or the loan takes longer than 5 years to repay. As the article explains, the loan balance is still considered a part of the 401(k), even though for tax purposes the participant has to pay tax on it. The deemed distribution is for tax reporting purposes only, because it really was not a distribution. That is why it is not an eligible rollover distribution, because it is still considered money that belongs to the 401(k) under the terms of the loan.

In other words, you can't roll something over until it is actually no longer a part of the original account balance.

On the other hand, a 401(k) that is cashed out no longer has any money in the account balance. Nothing in IRS Pub 575 says the outstanding loan balance can't be rolled over under the circumstances. Technically it is not a deemed distribution because the loan did not exceed $50,000 nor take longer than 5 years to repay. But it is still considered a distribution because the 401(k) was cashed out, in which case you have 60 days from the date the loan is considered distributed to the date it must be rolled over into a new qualified plan or IRA.

If anyone has any other citation to contradict what I just said, I would be glad to see it.

I think Bees has this covered in agreement with the IRS.

Reg. §1.72(p)-1 Q-12: Is a deemed distribution under section 72(p) treated as an actual distribution ...
A-12: No; ... Similarly, the deemed distribution is not eligible to be rolled over to an eligible retirement plan ...

Reg. §1.72-(p)-1 Q&A13 PLAN LOAN OFFSET. In the event of a plan loan offset, the amount of the account balance that is offset against the loan is an actual distribution for purposes of the Internal Revenue Code, not a deemed distribution under section 72(p).

Reg. §1.402(c)-2 Q&A9 Q-9: What is a distribution of a plan loan offset amount, and is it an eligible rollover distribution?

A-9: (a) General rule.
A distribution of a plan loan offset amount, as defined in paragraph (b) of this Q&A, is an eligible rollover distribution .... Thus, an amount equal to the plan loan offset amount can be rolled over by the employee (or spousal distributee) to an eligible retirement plan within the 60-day period ...

[Roberts]

But it is still considered a distribution because the 401(k) was cashed out, in which case you have 60 days from the date the loan is considered distributed to the date it must be rolled over into a new qualified plan or IRA.

You have 60 days to repay the loan upon terminating employment. You are not limited to 60 days to roll over into a new qualified plan (there is no requirement to move assets from a 401(k) upon leaving the job).

You are prohibited from transferring a loan balance.

[Bees Knees]

Here is a link which discusses this matter pretty fully. http://www.relius.net/News/TechnicalUpdates.aspx?ID=263.

It states: "A deemed distribution...is not an eligible rollover distribution." It also states: "The distribution of a loan offset is an eligible rollover distribution."

However, I am still not clear what the difference between the two is, but it appears termination of employment is the deciding factor?

The deemed distribution that does not qualify for rollover treatment in your linked article is talking about when the loan no longer qualifies for the distribution exception, such as when the loan balance exceeds $50,000, or the loan takes longer than 5 years to repay. As the article explains, the loan balance is still considered a part of the 401(k), even though for tax purposes the participant has to pay tax on it. The deemed distribution is for tax reporting purposes only, because it really was not a distribution. That is why it is not an eligible rollover distribution, because it is still considered money that belongs to the 401(k) under the terms of the loan.

In other words, you can't roll something over until it is actually no longer a part of the original account balance.

On the other hand, a 401(k) that is cashed out no longer has any money in the account balance. Nothing in IRS Pub 575 says the outstanding loan balance can't be rolled over under the circumstances. Technically it is not a deemed distribution because the loan did not exceed $50,000 nor take longer than 5 years to repay. But it is still considered a distribution because the 401(k) was cashed out, in which case you have 60 days from the date the loan is considered distributed to the date it must be rolled over into a new qualified plan or IRA.

If anyone has any other citation to contradict what I just said, I would be glad to see it.

[FEDUKE404]

Tax withholding is irrelevant

It looks to me like a "deemed distribution" takes place when the borrower defaults on the loan.

If the loan was still in good standing and is deducted from the distribution and the borrower COULD have
repaid it before taking the direct distribution into the rollover IRS, it is all right for the borrower to use
other funds to place an equal amount in the rollover IRA.

One new question occurred to me: money received first, then rolled over is supposed to have 20% tax withheld.
Does that mean a $ 13000 reduction for loan repayment would mean it was really a $ 16250 loan minus $ 3250 tax?
Or maybe it was reduced $ 10833 plus $ 2167 tax. I left a message on the client's phone asking about the tax WH.
Possibly the withholding is not required in this kind of situation.

It is always the gross amount, as shown on the Form 1099-R, not the net amount (such as decreased amounts due to withholding) that would have to be rolled over to remove the potential tax burden.

That is why institution to institution transfer (no taxes withheld!) is generally far better than touching the money. Also those IRS-mandated time deadlines ARE set in concrete!

As to whether federal tax withholding is "required" whenever a check is written to the taxpayer is something I cannot answer. There is a difference between "customary" and "required."

A simple explanation: Client closes out a $100k 401k, gets a check for $80k (20% US withholding), and later takes the $80k check to his whiz-bank brother who is an investment advisor to fund a new IRA. (Well, he did roll over the check, right????). Unless the client somewhere finds another $20k to give to his brother, he will be facing taxes/penalty on the missing $20k he did NOT roll over.

It happens all the time...............(and, as noted, frequently only discovered when it is too late to remedy the situation).

FE

[taxxcpa]

Deemed distribution

It looks to me like a "deemed distribution" takes place when the borrower defaults on the loan.

If the loan was still in good standing and is deducted from the distribution and the borrower COULD have
repaid it before taking the direct distribution into the rollover IRS, it is all right for the borrower to use
other funds to place an equal amount in the rollover IRA.

One new question occurred to me: money received first, then rolled over is supposed to have 20% tax withheld.
Does that mean a $ 13000 reduction for loan repayment would mean it was really a $ 16250 loan minus $ 3250 tax?
Or maybe it was reduced $ 10833 plus $ 2167 tax. I left a message on the client's phone asking about the tax WH.
Possibly the withholding is not required in this kind of situation.

[Burke]

Here is a link which discusses this matter pretty fully. http://www.relius.net/News/TechnicalUpdates.aspx?ID=263.

It states: "A deemed distribution...is not an eligible rollover distribution." It also states: "The distribution of a loan offset is an eligible rollover distribution."

However, I am still not clear what the difference between the two is, but it appears termination of employment is the deciding factor?

[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.

[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

[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.

[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.

[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.

[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

[appelman]

Ca va sans dire!

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

[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)

[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.