401K rollover question

[phorsenuf]

So at work today we were discussing rolling over 401Ks to an IRA. (And you all thought lunch ladies only talked about sloppy joes! )

If you do a direct rollover than there are no penalties compared to a non-direct rollover, correct? I know with a non-direct they hold 20% back and in order to avoid penalties you need to add that 20% back in to make it a full 100%.

Then someone brought up loans against a 401K. If you default and take the hit against it but still roll the rest over is that still considered a direct rollover? That one I didn't know. I tend to read a lot about financial and tax stuff to educated myself (for some reason I find it interesting) but that stumped me.

Anyone know?

 

[golfgal]

I am a little confused but you are correct that a direct rollover doesn't entail any penalties as long as it goes into a qualified account. Loans against a 401K, if allowed and not all plans allow this, can be penalized 10% depending on the provisions of the plan. If you default on the loan and then roll over the remaining portion of the 401K you can do that as a direct rollover however the previous company can keep the loan amount back. Say you have $100,000 in your 401K, take a loan for $20,000 leaving $80,000. You default on the $20,000 and try to roll over the remaining $80,000, they can take $20,000 out and roll over $60,000. Does this answer your question? You don't really want to take a 401K loan unless it is absolutely your LAST choice.

 

[phorsenuf]

I am a little confused but you are correct that a direct rollover doesn't entail any penalties as long as it goes into a qualified account. Loans against a 401K, if allowed and not all plans allow this, can be penalized 10% depending on the provisions of the plan. If you default on the loan and then roll over the remaining portion of the 401K you can do that as a direct rollover however the previous company can keep the loan amount back. Say you have $100,000 in your 401K, take a loan for $20,000 leaving $80,000. You default on the $20,000 and try to roll over the remaining $80,000, they can take $20,000 out and roll over $60,000. Does this answer your question? You don't really want to take a 401K loan unless it is absolutely your LAST choice.

I was afraid the question may have been muddled. What she wondered was if you still had the outstanding $20,000 and defaulted but then rolled that $80,000 is that 80k considered the full 100% for a direct rollover even though that 20k has now been removed. Or is it now considered a non-direct rollover because that 20k has been removed. I thought it was an awesome question and came home yesterday to research it but couldn't find anything.

I'm such a geek when it comes to this stuff. I don't know why I find it all so interesting. I actually love doing taxes too.

 

[Cheshire Figment]

A direct rollover is where all or part of a qualified retirement plan is rolled directly into another qualified retirement plan. The trustee of the old plan transfers the money directly to the trustee of the new plan.

If you have an open loan outstanding against a plan the owed amount cannot be transferred. If you have had $100,000 in a plan with a $20,000 open loan you can roll over $80,000. Depending on the agreement with the trustee of the old plan (or the employer) you can repay the $20,000 in which case it can then be rolled over, or the loan is cancelled and the $20,000 is reported to IRS as a distribution.