convert 401k to ira roth
i have lost my job but i have a 401k with them and i have an outstanding loan against it that i now can’t afford to pay back.they told me if i roll the plan over i won’t have to pay the loan. should i roll the money to an ira roth is my question.my understanding is there will be no penalties for this conversion. is this the safest thing to do?
Permalink Submitted by Alan Spross on Tue, 2010-04-27 16:30
I don’t think so.
In your situation the last thing you probably need now is a tax bill for converting to a Roth IRA, since you will be taxed and penalized on the defaulted loan. Even though 2010 conversions can be reported in 2011 and 2012, it would probably be best to wait until you have new employment and a better financial picture before converting to a Roth. You should probably roll the funds into a traditional IRA by direct rollover for now, and the only taxable amount will be your loan default. Later on you can convert if you expect to be able to pay the conversion taxes from other sources than taking them out of the IRA. But basically, no one should convert who expects their tax bracket in retirement to be lower than what they will pay in conversion taxes.
As for the loan, this is typically handled by an offset distribution in which the plan will pay off your loan by taking the balance from your 401k plan. That leaves you a choice of replacing those funds within 60 days from your distribution (direct rollover to an IRA) to prevent the loan payoff from being taxed and penalized or just paying the tax and rolling over the balance the plan will distribute.
It appears the plan rep only gave you part of the story, and did not tell you that you will be taxed and penalized (10%) for the loan payoff UNLESS you have the funds to replace the loan balance. You indicated that you cannot afford to do that.