401k/Roth IRA loophole?

[Guest MichaelEdward]

My 401k contributions are not taxed. I can borrow funds from them anytime and as long as I do not default on repaying them, they still are not subject to taxes. In repaying any borrowed money from my 401k, I repay both principal and interest to my account. My question is if I took $3500 from my 401k and deposited it into my Roth IRA and held on to it (Roth IRA) until my retirement in 7yrs at age 62, will I have avoided paying any tax whatsoever on my Roth IRA funds that I have over time been transferring from 401k to Roth IRA?

[Appleby]

The IRS does NOT allow you to move assets directly from a 401(k) plan or any other qualified plan to a Roth IRA. The assets must first be rolled to a Traditional IRA and then converted to a Roth IRA.

If all the assets are truly non-taxable, then you can convert them (the assets) to a Roth IRA and take a tax and penalty free distribution anytime after the conversion,

[Medusa]

Also it seems to me that you are in fact defaulting on the 401k loan in your scenario? If you make all the scheduled payments it is a non-issue.

[Guest MichaelEdward]

Medusa replies:

"Also it seems to me that you are in fact defaulting on the 401k loan in your scenerio ? If you make all the scheduled payments it is a non issue."

HOW am I defaulting? If I pay back the money I borrowed and interest and make my normal weekly contribution to my account, where's the default? If I didn't repay the loan then there would be a penalty plus taxation on the amount borrowed, that would be a default. Thanks.

[Medusa]

If you are making the repayments, tell me again where the loophole is. I don't see where you are getting any money out tax free. You took money out, you put it back in, and you are taxed at the point of distribution. Unless, as Appleby suggests, you are proposing a direct rollover to a Roth, which is not permitted, nor are rollovers permitted at all on loan proceeds.

[Guest MichaelEdward]

Thank you very much for answering my query! I didn't know if this could be done legally or not.

[Guest MichaelEdward]

There is no loophole because the scenerio I suggested isn't allowed by the IRS. Lord, I hope you understand THAT. Thanks and bye...

[BPickerCPA]

Michael,

If I'm understanding you correctly, there is nothing wrong with what you are proposing, but it really isn't any sort of loophole.

Assuming you are eligible, income-wise, to make a Roth contribution, the source of the funds is immaterial. So there is no reason why you cannot borrow 401k money to contribute to the Roth IRA.

You will have to repay the 401k loan, and that repayment will come from after-tax dollars. So if you were in the 50% bracket, you would have to earn $7,000 to put the $3,500 back into the 401k. Then when you later withdrew that $3,500 from the 401k, you would be taxed on the $3,500.

Taking it one step further, if you had to repay $4,000 because of interest on the loan, which would be non-deductible interest, you would have to earn $8,000 to have $4,000 after tax, and then you would be taxed when you later withdrew the $4,000 from the 401k.

Of course, if you default on the loan, that would also be taxable.

So, it's no loophole because you WILL pay tax on the money going into the Roth IRA, one way or the other.