Borrowing From Your 401(k) To Contribute To An IRA: Huh?
Last night I met a woman who has a fair amount of anxiety over being able to save for retirement and save for kids' college.She is the primary breadwinner and feels they aren't doing enough to save for their future.
After discussing 529s (college savings plans for your children), 401(k), and Roth and Traditional IRAs, she told me this bombshell: her accountant advised her to borrow against her 401(k) in order to contribute to a Deductible IRA.
Come again?
I have never heard of this and had to think for a minute.
She said that she is paying her 401(k) loan back, but doesn't like the concept of borrowing against her 401(k), even if the money goes straight into a Deductible IRA (NOTE: A Traditional IRA can be deductible or non-deductible, depending on your income).
Do you see why her accountant advised her to do this, even though it's ethically shady?
She gets 2 tax benefits on the same bucket of cash.
Tax Benefit #1 comes from putting those pre-tax dollars into the 401(k).
Tax Benefit #2 comes from pulling those same pre-tax dollars out of the 401(k), in the form of a loan, and putting them in a deductible IRA, hence getting another tax break.
Yowza, I told her that while technically it may be ok, in spirit it's taking 2 tax deductions on the same pot of cash, and that while the IRS may not ever put 1 and 1 together, she may not want to do this in the future since it's definitely gaming the system.
She immediately freaked out.
I said whoa, calm down, just think it through so you understand and realize that it's highly remote the IRS will, or even can, link these 2 actions together.
But that yeah, you may not want to do this in the future just for that reason.
Separately she also has a commission-based financial advisor that sold her Putnam Funds.
That was a whole separate conversation, in which she didn't even understand the difference between a guy selling front - load funds (calling himself a "financial advisor") and a fee-only financial planner.
I told her, look, don't feel bad, at the end of the day what counts the most is the fact that you are living below your means and allocating money towards your future.
Dang, sure would like to get ahold of her crap "financial advisor" and her renegade "accountant".
posted by finance girl @ 8:45 AM
3 Comments:
I'm not an expert in 401K's... but I'm not so sure that borrowing against your 401K to put in a Deductible IRA is as slick as that financial advisor might think it is. What about:
-401K loan fees?
-Payments you make toward your 401K loan are taxed
-...Therfore you'll get taxed when making the payment back to your 401K and again when you withdraw the money in retirement... double taxation.
Just a few thoughts.
erm, yeah, couldn't agree with you more.
I didn't know the loan payments back to your 401(k) are with after tax money though, that makes it even worse.
It's not illegal, not 'gaming' anything. It may make sense depending. Is she already maxing out the 401(k)? If not, just up the 401(k) deposits by the amount she was willing to pay on the loan. If the 401(k) is maxed, and she has little or no other debt, the $5K loan to fund the IRA can help her jump start it, but it implies she has no other money to put in. Maybe that's the part that bothers me about that loan suggestion. I advise the loan to pay off 24% credit cards, and at the same time make both the payment and higher 401(k) deposits.
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