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Rolling over my 401k into a rollover IRA then withdrawing funds?

I am thinking about changing jobs. I currently have outstanding 401k loans in my current emloyers plan. I'd like to borrow money from a relative, pay off the loans, rollover the 401k into an IRA, then withdraw the funds to pay back my relative. If I do this, will I face any tax liabilities or penalties. I have read that if it is a rollover IRA that this can be done. I also think I have done it before.

May 16, 2013 by Dan from Holtsville, NY in  |  Flag
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6 votes


OK it looks like everyone else has dished up the required "lecture" about taking retirement funds earmarked for your future and using them for today, as well as having adequate emergency funds, so I'll avoid those topics. Here is a possible solution:

1) First, make sure your NEW job has a 401(k) that accepts rollovers from old 401(k)'s. Make sure your new 401(k) also allows you to take a loan from it just like your existing 401(k) does. Make sure you can IMMEDIATELY enroll in the new company's 401(k) - that there isn't an extensive waiting period before you can enroll. Then take the new job.

2) Borrow the money from your relative that you mentioned.

3) Use the money you borrowed from your relative to pay off your existing 401(k) loan. If you don't do this - the loan gets automatically "forgiven" when you leave - but the money you pulled out is treated as an early withdrawal with a 10% penalty in addition to being taxable.

4) Change jobs and roll your OLD 401(k) into your NEW employer's 401(k).

5) Borrow the amount of money you need to pay off your relative from your NEW 401(k).

You will now find yourself in EXACTLY the same position that you are now - except with a different job. No big deal. NOW work diligently to get that 401(k) loan paid off, as 401(k) loans can effectively "job lock" you if you don't have the money to pay them off.

The "rollover IRA" concept that you mentioned is, in fact, correct - it is known as a "Conduit IRA." However, you must roll the "Conduit IRA" into your new 401(k) and THEN take a loan from the 401(k) - you cannot simply withdraw the funds from this IRA to pay off your relative or to pay off a 401(k) loan without the 10% tax penalty.

Jon Castle http://www.WealthGuards.com

View all 4 Comments   |  Flag   |  May 16, 2013 from Jacksonville, FL
Michael Steven Greenberg, CFP®

Ditto, Jonathan.. great solution!

Flag |  May 16, 2013 near Delray Beach, FL
Rich Winer

That's way too simple, Jonathan! LOL. I will be kicking myself for the remainder of the day for not having thought of that. I will have to reward you a thumbs up vote. That said, I think we would all agree that Dan should get some help budgeting, saving, investing and paying off that loan.

Flag |  May 16, 2013 near Woodland Hills, CA

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Peter C. Karp Level 20


You should be able to payoff your outstanding loan in your 401(k) account with your current employer by writing a check for the outstanding balance and interest. You will need to check with your HR department to find out what specific forms you will need and also to determine the payoff amount. As long as you are still employed with that company you will not be able to transfer your account to an IRA rollover. Once you terminate employment you can either transfer your 401(k) assets to an IRA rollover or to your new employer’s 401(k) plan without tax liabilities or penalties. However, if you subsequently withdraw the funds from the IRA rollover account you could face a potential penalty of 10% if you are younger than 59 1?2 , and the withdrawal will be treated as a taxable event. It would be wise to work with your accountant to determine the best options for your specific situation.

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Comment   |  Flag   |  May 21, 2013 from San Francisco, CA

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Hi Dan. Unfortunately, if you are under 59 1/2, you will most likely be subject to tax and the 10% penalty, regardless of whether the distribution is made from a 401(k) or Rollover IRA. Both accounts are treated the same as it relates to the IRS.

Comment   |  Flag   |  May 16, 2013 from Virginia Beach, VA

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Dan, you sure will. First, you took out a loan of pre-tax dollars, and are re-paying the loan with after-tax dollars. This ship has already sailed, but unless it is a dire emergency, you should not be taking loans from your qualified plan.

Assuming you are not 59 1/2, if you default on the loan you will likely be subject to income tax plus a 10% penalty. If you pay it back, convert it to an IRA, then take it out from the IRA, you will be also paying income tax plus a 10% penalty. If you are 59 1/2, the penalty won't apply.

Either way, you will be paying income tax plus a 10% penalty. It might be easier to just not get relatives involved.

Comment   |  Flag   |  May 16, 2013 from Delray Beach, FL

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Rich Winer Level 20

There are ways to take money out of an IRA or 401K prior to age 59 1/2 but they are complex and probably would not be worth undertaking. If I were you, I would leave your money in the current plan until you can afford to pay off the loan or work out an arrangement with your relative to pay back his or her loan to you over time for a source other than your retirement account. It's never a good idea to liquidate a retirement account because you will lose future tax-deferred growth on the money you withdraw. You might also incur taxes and penalties. Also, because you are limited as to how much you can contribute each year, it might take you years to replenish the amount you withdraw. The fact that you've taken a loan from your 401K and do not appear to be able to pay it back anytime soon from your income tells me that you might be well advised to hire a financial advisor to help you come up with a plan to pay off your loan, help you maximize your investments inside your 401K and help you with your cash flow and budgeting (to avoid needing future loans).

Comment   |  Flag   |  May 16, 2013 from Woodland Hills, CA

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Hi Dan! As I read your question, I see two things that jump out. One: the word loans (plural). Two: this has happened more than once. The comments you have received already are on point, and I would like to recommend that you work on saving 3 to 6 months worth of income for an emergency fund. If you are taking loans from your retirement plan, you are either overspending on a regular basis, or you don't have ample funds to cover emergency situations. Pay off your loans as soon as you can, then work toward building your emergency fund. This will protect you from running into this issue in the future. Good luck!

Comment   |  Flag   |  May 16, 2013 from River Hills, SC

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