Traditional IRA Rollover to 401k - Is a loophole?

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JPW
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Joined: Thu Jul 11, 2019 3:08 pm

Traditional IRA Rollover to 401k - Is a loophole?

Post by JPW » Thu Jul 11, 2019 3:20 pm

I hesitate to almost ask this question since as I peruse the posts here I can tell people are way more investment savvy than I am, but I'm doing my best to learn. I'm assuming there might be a somewhat easy explanation for this, but since I can't really find an answer, I thought I might post here.

I attempt to max out my 401k each year. I also have a Traditional IRA with another company. In years past I occasionally have been given money back from what I've invested in my 401k in a given year due to some kind of anti-discrimination policy. Basically, as I understand it, if enough people are not investing in a similar fashion as I am within the company I work for then that disparity can be viewed as being unfair in some way so they return some of the money.

That is fine since I can invest it elsewhere. So what I've done in the past is put this money into a Traditional IRA. However, I've just learned that I can take that same money from the IRA and simply roll it over back into my 401k without any penalties and it does not impact the yearly maximum amount allowed for contributions. How is that possible? Had I known about this earlier, I would have just followed this same process each year and essentially gained what I was after to begin with, that is, having all the money in the 401k.

Does anyone know if I'm missing something here? It seems odd to me that I'm forced to take money out of the 401k, but don't suffer any kind of penalty to put the same amount of money back into it as long as it has been initially put into a Traditional IRA first. Any confirmation or explanation would be appreciated.

anon_investor
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by anon_investor » Thu Jul 11, 2019 3:58 pm

Annually IRAs have contribution limits. You can always contribute a certain amount to your IRA regardless if you 401k plan administrator give you back money each year. You are really not getting any more tax protected space, it is just that you are shifting where your tax protected funds ares located (from your TIRA to 401k).

pwon
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by pwon » Thu Jul 11, 2019 4:06 pm

Yes, this is possible. But I'm not sure how this is considered a loophole - after all, you're not receiving any tax breaks whether the fund is in your IRA or 401k.

lakpr
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by lakpr » Thu Jul 11, 2019 4:17 pm

JPW,

If you are covered by a retirement plan at work, then your ability to contribute to a traditional IRA and take a tax deduction on the contribution may be limited. You need to be under certain income thresholds for being able to contribute to both 401k and traditional IRA. That income limit is $73k for single and $101k for Married Filing Jointly (2018 limits; they are increased by 1k each for 2019).

Please confirm that you meet these income thresholds.

If you do not meet those thresholds, you may have done what is called a non-deductible contribution to your traditional IRA. Thing is, this won’t be obvious until you filed the tax returns. There are no income limits to make non-deductible contributions to a traditional IRA.

Now, as far as rolling over the Traditional IRA to 401k goes, you can ONLY rollover the balances that are pre-tax. 401k plans cannot, by ERISA law, accept post-tax, non-deductible contributions. If you rollover such balances to your 401k without knowing fully, or perhaps even intentionally, the entire 401k plan can get invalidated. I am sure there will be very angry colleagues at your work in that case!

Before rolling over, therefore, find out for sure if you did take a tax deduction for the amounts contributed to Traditional IRA. You will need to revisit your tax returns. There is a way we can fix it even in this case, but rather than ranting out on a hypothetical scenario, would like you to confirm the facts first.

retiredjg
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by retiredjg » Fri Jul 12, 2019 6:51 am

If you are having contributions returned to you from your 401k, you are most likely making a fair amount of money. Making a lot of money does not mean you cannot contribute to traditional IRA but it does mean you cannot deduct the contribution to tIRA from your income.

If you have been doing that, it is called a "non-deductible contribution" to tIRA. Your 401k is not allowed to accept non-deductible contributions, so you have probably not been missing out on anything there because that money cannot be rolled to 401k anyway.

When a person makes non-deductible contributions to tIRA, it is supposed to be documented on your taxes each year using Form 8606. This is to prevent you from paying taxes on the money a second time (when you take the money out).

If you have not been doing this documentation, it can be done now if you have records of your contributions to the tIRA. You can download old Forms 8606 from the internet and fill them out by hand and send them into the IRS.

In order for us to help you further, you need to see if all those IRA contributions have been deductible or non-deductible or maybe a combination of the two.

MathIsMyWayr
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by MathIsMyWayr » Fri Jul 12, 2019 7:19 am

Whether it is a loophole or not depends on a personal standard. We may even consider 401(k) unfair to those who do not hold decent jobs, without 401(k) plans. I am not a lawyer, but I believe that getting the most benefit within the laws and regulations is allowed though some areas are grey. Finding and getting benefits is solely your responsibility. There are discussions on how to get subsidies on this board all the time.

retiredjg
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by retiredjg » Fri Jul 12, 2019 8:04 am

As for the question in the title...
Traditional IRA Rollover to 401k - Is a loophole?
No, that is not a loophole. It is simply rolling tax-deferred money from one kind of account to another. It is the same as rolling 1 IRA into another IRA or 1 401k into another 401k.

But it appears the money in your tIRA is not tax-deferred. If that is correct, you cannot do this rollover.

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Nate79
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by Nate79 » Fri Jul 12, 2019 8:31 am

Traditional IRA and 401k each have their own separate contribution limits. This is not a loophole but as has been pointed out it doesnt work the way you are thinking.

Katietsu
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by Katietsu » Fri Jul 12, 2019 8:42 am

If it is correct that you have been making non deductible IRA contributions, then there is a different course of action you could pursue.

You should consider a Roth conversion and future “back door Roth”. You may need to move the pre tax portion of your traditional IRA balance into your 401k first to make this worthwhile.

Come back and post more details and you will get a better answer.

Alan S.
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by Alan S. » Fri Jul 12, 2019 11:54 am

There is an IRS rule that regardless of how many IRA accounts you have, if you roll IRA money into your 401k your entire pre tax balance for all your IRAs is deemed to be rolled over first. This is an exception to the usual pro rata rules.

However, if you mess up and actually roll IRA basis into your 401k and your plan finds out about it, the plan will not be disqualified but will have to make a corrective distribution back to you of the IRA basis rolled in plus any earnings generated on this amount while in the 401k.

Most likely such a distribution will be reported to you with code E on the 1099R. Code E distributions are not eligible for rollover so you cannot roll the corrective distribution back into your IRA.

The IRS has not published clear guidance on how to handle this mess. The 1099R issued to report the direct rollover to the 401k will not reflect IRA basis as the custodian does not know your basis. If non deductible contributions were included that were not eligible for rollover, you should report that portion on Form 8606 as a tax free distribution of your IRA basis. Then when the 401 distributes this basis back out with a E coded 1099R the only taxable portion should be the earnings generated in the 401k plan. All this will not generate much in current taxes (only tax on the earnings), but you will have lost this amount from both your IRA and the 401k and created a major filing hassle as well as irritating your 401k administrator.

Topic Author
JPW
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by JPW » Fri Jul 12, 2019 12:43 pm

I sincerely appreciate all the responses. It is a bit overwhelming just because I know this is a space I should probably know more about, but at least me being here I guess proves I'm trying. Admittedly, some of what you folks have passed on is over my head. Some people have asked for greater detail and I don't think I've probably asked my question very well so let me ask it like this.

Here is a typical scenario:

1. In 2018 I put in close to the max of my company's 401k at ~$18,000.

2. In early 2019 I receive a check from the company managing this 401k due to whatever anti-discrimination policy they have. It is usually around $5,000. They allow me to keep the gains I made with this money over 2018 and deduct taxes from it. That seems fair to me.

3. Since I want to invest this money for retirement I then take this $5,000 and put it into another firm's Traditional IRA that I have.

4. I now learn that I can then take that same $5,000 that I put into the Traditional IRA and roll it over BACK to my 401k without any penalties or impacting that yearly contribution limit I might be moving toward in any way.

So it is 4. that confuses me because it seems to me that the net result of all this leave me with exactly what I wanted to have back in 1., that is, having all $18,000 in my 401k. I probably should just stop questioning it, accept that it is what it is, and be thankful that it is what it is because it seems to work in my favor. The only reason I asked here is because it feels like I am missing something. If I'm not, then that is great. It just seems weird to me that there is such a simple avenue to move around the anti-discrimination policy since this is essentially what it is. Ultimately, I guess my question is, does this seem like an acceptable "loophole" and is there any reason I shouldn't do this?

lakpr
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by lakpr » Fri Jul 12, 2019 1:07 pm

Your step 3: you are not eligible to take a tax deduction for that $5500. Unless you made less than a certain income threshold. What was your income and filing status at the time you contributed $5500?

Given that you are classified as HCE and 401k contributions are returned to you, I suspect your income exceeds the thresholds set by IRS, and that this contribution is therefore NOT tax deductible.

Your step 4: it is possible to roll IRA money back into 401k, but ONLY if your step 3 is tax deductible. It is the ERISA law. That is what we are trying to ask. If it is not tax deductible, you CANNOT roll the IRA back into 401k plan.

Alan S.
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by Alan S. » Fri Jul 12, 2019 1:38 pm

Just look at your tax returns for the last few years you have been making these TIRA contributions.

Was your contribution deducted on the first page of Form 1040, or did you file Form 8606 to show the contribution as non deductible? Must be one or the other. Did you file returns yourself or did you hire a tax preparer? If you hired a preparer and you told the preparer of your IRA contributions, the preparer would deduct the contributions if you were eligible.

retiredjg
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Re: Traditional IRA Rollover to 401k - Is a loophole?

Post by retiredjg » Fri Jul 12, 2019 5:35 pm

JPW wrote:
Fri Jul 12, 2019 12:43 pm
4. I now learn that I can then take that same $5,000 that I put into the Traditional IRA and roll it over BACK to my 401k without any penalties or impacting that yearly contribution limit I might be moving toward in any way.
This is where you are going off the rails. From what you have told us, it is very unlikely you could roll that $5k that you put in the tIRA into the 401k.

Why not? Because it is unlikely that $5,000 was a deductible contribution to tIRA. (Only deductible contributions can roll into your 401k.)

Why not? Because it appears you make too much money to make a deductible contribution to tIRA (deductible meaning you could deduct it from your taxable income).

Why? Because you made so much money that part of your 401k contribution was returned to you. This does not happen to people with lower salaries. Only people with lower salaries can deduct a contribution to tIRA.

You can verify if those contributions were deductible or not. Your tax return will tell you. Line 32 of the old tax return form. I don't know where it is on the new postcard size form.

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