rolling 401k with loan
A friend of mine recently changed jobs. His 401k balance is approx. $90,000, and he has a $5,000 loan on it.
He contacted the 401k provider to check into paying off the loan, but they told him that it is too late to pay off the loan and that he will receive a 1099 for the $5,000.
My question is, can he rollover the $85,000 and put an additional $5,000 from another source with it, in order to avoid the taxes and 10% penalty?
Thank you!
Permalink Submitted by Alan Spross on Mon, 2012-05-21 22:17
It’s not clear that he received all the information he needed from the plan administrator.
There are two types of defaulted loan distributions:
1) A “deemed distribution” that shows on the 1099R using Code L.
2) An “offset distribution” that is reported on the 1099R using the usual Code 1 (prior to 59.5) or Code 7
An offset distribution can be rolled over, but a deemed distribution cannot. He must find out what code the 1099R for the 5,000 will show, and if it is Code L he is out of luck.
If he rolls the 85k in a direct IRA rollover, the 1099R for that 85k with include code G in Box 7. There will be another 1099R for the 5,000 and this is the one where the coding as described above is critical. If a deemed distribution is avoided, he has 60 days from the date of the 85k distribution to roll the 5,000 over to an IRA. He should be able to get this info now if he gets to the right people.
If he cannot get an answer and wants to cover his bases, he could make a 5,000 rollover deposit to his IRA and then if the plan blindsides him with an L coded 1099R he can just treat the 5,000 rollover as an excess IRA contribution and remove the contribution. Of course, he would owe tax and penalty on the 5,000 if the L code appears.
Since 5,000 happens to be the same amount as the regular IRA contribution limit, he should be sure the IRA contribution gets coded as a ROLLOVER as that is the only way it can be used to offset the taxes from the 1099R (if NOT coded L) for 5,000.
Permalink Submitted by Jason Frank on Tue, 2012-05-22 13:18
Thanks for the extremely helpful response! He did mention the term “offset” was used, so it looks like he should be able to do the rollover. Thanks again!
Permalink Submitted by Ratu Joni on Wed, 2012-05-23 05:41
very interesting information. I agree with a lot of this content.
Permalink Submitted by Jo Mejia on Mon, 2012-05-28 11:08
I think that changing a job is a very risky business and it should be thought carefully over before anything is done.