Prepping 401k w/loans for rollover

Submitted by Robert Vashko on Fri, 2023-06-16 12:21

Not an IRA case per se, but one that is prepping for an IRA rollover.

Client has 401k with a Roth component. Roth contributions equal about $20k. Roth contributions first started over 5 years ago.

Client is separating from service and wishes to roll the 401k to her IRA. The 401k has about $12k in outstanding loan balance. Client is under 55.

If the plan allows, can the client pay back the loan out of the Roth post-tax dollars (avoiding both a taxable distribution and a 10% penalty issue) prior to executing the rollover? If so, the remaining $8k of post-tax dollars would be rolled to a Roth IRA, and the pre-tax dollars rolled to a Trad.

Please and thank you.



Submitted by Alan - IRA critic on Fri, 2023-06-16 17:11

  • Client could ask the plan, but I think that this would require a reportable taxable distribution of enough of the Roth balance to the client and if the plan permits the client could pay those proceeds back to the plan to avoid an offset distribution of the pre tax loan amount. In other words, the plan could not simply reduce the Roth balance directly to pay back a pre tax 401k loan without a distribution. For example, if the Roth 401k balance consists of 16k of contributions and 4k of gains, then 20% of any distribution would be subject to 20% withholding tax and penalty. Therefore, to fund the taxes and penalty on that 20% and still have 12k left to repay the loan, the distribution would have to be around 13k. Once the loan is repaid direct rollovers could be done to the appropriate IRA types. 
  • A better alternative may be to just accept the offset distribution 1099R, but then use the extra time (to 2023 tax due date plus extensions) to take a tax free distribution from the resulting Roth IRA (tax free per the ordering rules) and complete the rollover of the pre tax offset distribution by the deadline. The offset 1099R taxes would be eliminated by reporting this rollover. There would be no tax or penalty or reliance on interpretation of the plan provisions. Also, fewer complications. Net result would be the same – use of Roth funds to avoid tax on the offset distribution. 

Submitted by Robert Vashko on Fri, 2023-06-16 18:41

Thanks. So you’re saying split the direct rollover into a Trad for the pre-tax and a Roth for the post-tax, then take a contribution distribution from the Roth IRA (after the dust has settled) to deposit into the Trad?  In other words, take a withdrawal from the Roth IRA to match the entire offset (including the 20% withholding) and then shove it into the Trad as an indirect rollover?If so, is that a 60-day deadline from the date of the offset?  You mentioned a deadline of 2023 tax filing deadline, so I am not sure what her time constraint is.  Thank you!

Submitted by Alan - IRA critic on Fri, 2023-06-16 20:25

Regardless of when the offset distribution is made, the rollover deadline is not 60 days, it is the tax due date including any extension filed. This would be reported as a rollover of the 401k offset distribution. The Roth distribution should be non taxable assuming that there is at least 12k of regular Roth contribution basis in the Roth IRA.  There would be 4 1099R forms –  1) Offset distribution from pre tax 401k reported as a rollover to TIRA on Form 1040  2) Direct rollover of rest of pre tax 401k to TIRA  Code G  3) Direct rollover of Roth 401k to Roth IRA  Code H  4) Roth IRA distribution equal to the gross offset distribution Code J. 

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