72t & 401k loan

Submitted by Ed on Fri, 2014-01-17 04:16

I have a client who will starting to take 72t distributions this year. She also has a 401k loan which she can not pay back.

Will the recognition of the 401k loan as income affect the 72t distributions?

Thanks

Gary



Submitted by Alan - IRA critic on Fri, 2014-01-17 17:05

She should roll the 401k over to an IRA before starting a 72t plan, as it is risky to use a 401k plan due to lack of control, particularly with a loan involved. What was client’s age when separation of service will occur?



Submitted by Ed on Sat, 2014-01-18 01:07

She is 55 this year,2014she is in the process of rolling everything over now. The problem is she has a $26k loan against her 401k she is unable to payoff so when she separates from service,2014, she will have to recognize the the $26k as income.will the recognition of this income affect her 72t distribution amount for 2014? thanks



Submitted by Alan - IRA critic on Sat, 2014-01-18 04:47

She can take penalty free distributions directly from the plan under the age 55 separation from service exception. If the loan is not paid off, it will either be a deemed distribution or an offset distribution. She should get the details of that from the plan and also see if she can take flexible distributions until age 59,5. That would avoid the risks of a 72t plan where her distributions would be limited anyway to less than 5% of the account balance annually. 



Submitted by Ed on Sat, 2014-01-18 14:58

Thank you for your helpi am not familiar with the ” under the age 55 separation from service exception”. Could ypu please elaborate? thanks



Submitted by mk foss on Mon, 2014-01-20 17:34

In general a 10% penalty applies when someone under age 59.5 takes a distribution from a retirement plan or IRA. When someone is participating in a qualified plan (401k in this example) and if they separate from service after age 55, there is no 10% penalty on a retirement distribution. So the 401k loan that is paid by offset will be taxable to this individual but there should be no 10% penalty on it. 



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