My client wants to initiate an indirect rollover from her 401(k) to purchase a new home, then repay within 60 days once the current home is sold. Do all 401(k)s mandate a 20% Federal Income Tax deduction that has to also be paid back in the 60 day window?
Except for a direct rollover, the 20% minimum federal tax withholding on a rollover-eligible distribution from a 401(k) is a statutory (tax code) requirement.
If the client has the option for a 401k loan, it would eliminate the issue of missing the deadline for the 60 day pay back, or mandatory tax withhlding. The interest owed would just be for a few months. Just a thought.
Permalink Submitted by Alan - IRA critic on Mon, 2023-06-26 20:09
While this is a risky idea due to failing many 60 day deadlines contingent on real estate closing dates, if the 401k was directly rolled to an IRA (no withholding), then a distribution from the IRA could be done without withholding. There is also a 10,000 first home penalty exception for an IRA distribution, but not from a 401k distribution. That said, only one 60 day rollover can be done within 12 months for IRA distributions, so there is a trade off between the withholding and the rollover limitation. But the main risk is that the 60 day deadline is missed and the entire distribution is taxed and penalized. I would advise against this plan unless client has high stress tolerance. The IRS one rollover limit was put in place to eliminate the practice of using IRA funds for short term loans.
Permalink Submitted by Denise Sowell on Tue, 2023-06-27 19:08
To be clear, the client can execute a Direct Rollover to an IRA, then initiate a 60 day rollover immediately from the IRA. The direct rollover does not count in the once/ year 60 day rollover limit. Correct?
Permalink Submitted by Alan - IRA critic on Tue, 2023-06-27 19:47
Correct, the direct rollover does not count. But the IRA distribution, for which withholding can be declined will count if rolled over, so client cannot have rolled over a prior IRA distribution taken in the prior 12 months, nor will client be able to do another IRA 60 day rollover for the next 12 months.