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#24514 - 12/23/04 08:54 PM Roll-Over 401K $ to 529
JamesL Offline
Junior Member

Registered: 12/23/04
Posts: 1
Loc: Houston, TX
I am interested in creating two 529 accounts for my grandchildren. Can I roll over 401k money or do I need to withdraw it first and pay federal income tax on it? I am over the age limit for early withdrawing.

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#24515 - 12/24/04 05:10 AM Re: Roll-Over 401K $ to 529
rsinj Offline
Member

Registered: 11/16/03
Posts: 1160
you cannot move money from a savings vehicle where you contributed non-taxable dollars to one which accepts only taxable contributions.

you'll need to withdraw the money from the 401k, pay taxes and then on top of that 10% penalty because a 529 contribution is not a hardship withdrawal.

if you plan to use the 401k ultimately for the college money regardless if you need to pay taxes, then you should leave the money in the 401k as it is a better savings vehicle - because it is with tax-free money and it is already there. there is no sense in taking the money out now, paying taxes and penalty simply to move into another savings vehicle - you will immediately have less investment dollars - probably about 30% to 40% less after penalty/taxes. since the money is already growing tax free, leave it there, use a similar investment option within the plan, and then when it is time to use the money for college, then take the money out. putting it to use for college tuition does qualify for a hardship withdrawal by IRS rules - so you would only have to pay taxes at that time years from now and no penalty. additionally, with money you contribute to your 401k, I assume you're getting some type of matching contribution from your employer? you cannot do better than this with a 529 - you are getting tax-free contributions, and additionally an employer match - which in itself is most likely more than the return you could expect from any 529. if you get a dollar for dollar match (or even one for two match) that is 100% (or 50%) immediate return on your investment. again, there is no 529 that can match that - and be investing with before tax money.

in the mean time, you have more money invested in the 401k which can compound tax free earnings.

you can always start a 529 with after tax money without tapping the 401k.

lastly, many folks here would argue that you should not raid retirement savings for college tuition/savings purposes. you have the opportunity to get financial aid for college costs, you don't have that ability for retirement savings.

[This message has been edited by rsinj (edited December 24, 2004).]

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#24516 - 12/24/04 03:22 PM Re: Roll-Over 401K $ to 529
russthomas Offline
Member

Registered: 11/05/04
Posts: 18
Loc: hot springs, ar, garland
The penalties referred to above are dependent on your age. I generally agree with the above response, but since you are a grandparent there is a chance you are old enough to withdraw without penalty.

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#24517 - 12/24/04 04:02 PM Re: Roll-Over 401K $ to 529
tweakman Offline
Junior Member

Registered: 12/23/04
Posts: 4
Now I'm confused. I'm aware of a penalty for early withdraws from an IRA. But the 401k has no such penalty...does it? When you leave your job, you can take all your 401k money and pay normal income taxes on it.

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#24518 - 12/24/04 06:36 PM Re: Roll-Over 401K $ to 529
bwilk Offline
Member

Registered: 05/14/01
Posts: 3345
Loc: AZ
Only if you roll it into an IRA or your next employer's 401k can you avoid the penalty and the tax. Same 59 1/2 rules apply for penalty free withdrawals. Otherwise no one would ever move funds into an IRA because that would make it eligible for penalties that would never be enforced on 401k funds.

[This message has been edited by bwilk (edited December 24, 2004).]

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#24519 - 12/27/04 09:34 PM Re: Roll-Over 401K $ to 529
blackdog Offline
Member

Registered: 12/11/04
Posts: 84
Loc: Larchmont,NY
JamesL -
I believe that if you are still working & contributing to the 401K you can take a loan from the 401K. You will pay no tax on the loan proceeds. You can contribute the loan proceeds up to 55G (= 5years gifting allowance) to each grandchild when you open the 529. In this way 401k money can effectively be rolled into the 529 but consult an accountant to make sure.

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#24520 - 12/27/04 10:23 PM Re: Roll-Over 401K $ to 529
bwilk Offline
Member

Registered: 05/14/01
Posts: 3345
Loc: AZ
Still a bad move though. You are now paying interest in after tax funds to your 401k for a non-guaranteed return in the 529. This is a really bad idea.

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#24521 - 12/29/04 02:29 PM Re: Roll-Over 401K $ to 529
blackdog Offline
Member

Registered: 12/11/04
Posts: 84
Loc: Larchmont,NY
bwilk, the interest is paid to yourself via the 401k thus is neutral. If you are still contributing to the 401k the loan payments come out of your contributions so you end up contributing less to the account over the 5 year payback period. It sounds to me like the poster was looking for some way to repurpose some or all of his 401k money without having to pay distribution taxes and the loan is a legal but limited way to do it. You have to be a contributing employee for the loan to work. You will not be allowed to borrow more than 50% of your 401k or an amount that can be serviced by the maximum contribution, whichever is less. This is not a terribly bad idea for non-guardian grandparents. For parents and guardians, I would advise otherwise. The reason is that you would be making funds visible to the financial aid calculation that would not otherwise be visible.

As to a non-guaranteed return I would beg to differ. Firstly, the 529's I've seen (NY &NH) offer a fixed interest investment category for the risk averse. Also, qualified 529 withdrawals are tax-free. So the loan idea effectively moves tax-deferred money into a tax-exemptable status. Finally, many states, like my NYS, offer a state income tax deduction for 529 contributions. So there are many built-in wins for the 401k loan idea.




[This message has been edited by blackdog (edited December 29, 2004).]

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