Loan against IRA?
A Federal employee age 55 has a $600,000 TSP with an outstanding $50,000 loan. She is about to separate from service. If the loan is not paid back within 90 days of separation, it becoms a taxable distribution. She wants to avoid that and has been advised to rollover a portion of the TSP to an IRA and then take an “equity-based” loan against the IRA to pay the TSP loan! My understanding is that an IRA can not be used as collateral for a loan, and that borrowing money from an IRA is a prohibited transaction, and taxable unless put back into the IRA within 60 days. In addition, even a partial withdrawal out of the TSP makes any outstanding loan immediately taxable. It seems to me this would be a self defeating strategy. What am I missing here?
In addition, she has $47,000 in an Roth conversion IRA that was converted over 10 years ago. If she took a withdrawal from this Roth, wouldn’t all of it be subject to a 10% penalty since she’s under age 59-1/2? Also, do the same 60 day rules for an IRA for withdrawing money and then putting it back apply to a Roth as well?
You comments would be most appreciated.
Permalink Submitted by Alan Spross on Mon, 2011-08-15 17:44
You are correct. An IRA cannot be used as security for a loan. She should find out if the TSP will be processing a taxable deemed distribution or due to the separation from service will offset the loan against the plan balance. An offset distribution can be rolled over within 60 days, a deemed distribution cannot.
She could probably buy some time if the above will be an offset distribution by taking Roth IRA funds to pay back the loan or complete the rollover to a TIRA. But then within 60 days the Roth distribution must be replaced from some other cash source to prevent the loss of funds from the Roth IRA. Since the conversion is more than 5 years old, those conversion funds can be withdrawn without tax or penalty.
The net affect would be the loss of Roth funds to fund either the loan repayment or the rollover of the balance to a TIRA account to avoid a tax bill. Either way, her retirement plans balance will take the hit.
Permalink Submitted by Sidney Poretsky on Mon, 2011-08-15 19:34
ATSP representative confirmed that any loan amount not paid off within 90 days of separation will be considered a taxable distribution. I assume that’s what you meant by a “taxable deemed” distribution, but I’m not sure what an “offset distribution” is.
Also, I thought the Roth conversion funds had to be held for 5 years AND to age 59-1/2, whichever is later. If these funds can be withdrawn at age 55 without tax or penalty, it seems obvious she should use this money to pay down the TSP loan and reduce the taxable amount to $3,000. Her retirement plans will still be down by $50,000, but at lease she will not have to pay tax on the whole amount.
Please let me know if I’ve missed anything here. Thanks.
Permalink Submitted by Alan Spross on Mon, 2011-08-15 19:48
The Roth conversion holding period is only 5 years or until 59.5 which comes FIRST. Therefore these old conversion funds can come out tax and penalty free, but only after the balance of any Roth regular contributions come out first. The regular contributions are also tax and penalty free.
If the loan is paid back, it also avoids the early withdrawal penalty on the distribution as well as ordinary taxes. If she wants to rebuild the Roth IRA she would have to start a new conversion plan, and of course that is when the tax hit would occur.