Made pre-retirement Roth IRA withdrawal - Attempting to pay back within 60 days to avoid tax

[phxphun]

Up front, I realize the best answer to our question is "see a retirement planner or tax specialist".   And we do now have an appointment with one.  Unfortunatley, we weren't able to get in to see one before the now approaching 60-day deadline that will end our ability to deposit money back into the Roth IRA we took it out of and avoid paying taxes on it.  

My husband has a Roth IRA, I have a 401k.  We were faced with a large emergency need, so we took a $40K distribution from his Roth and would like to re-deposit that $40K within the next 20 days to avoid paying tax on it - and because we believe that's the better place to save toward retirement.    

We're both just over 59 1/2  years old.  My 401k is strong toward our overall retirement plan.  We have $400K equity in our home valued at $720K.  Our credit scores are both 810+.

So our options to get the money back into the Roth are to take the $40K out of my 401k or take out a home equity line of credit.   We'd pay 26% taxes on the 401k distribution and we'd lose any future growth potential on it.  On the other hand, we'd pay interest on the HELOC and we aren't certain we'll be in the house more than a few more years. 

In general, is one of these clearly a more overall effective way to go? Any pitfalls to be aware of?

[bada_bing]

As far as withdrawing money from your 401K, you should check the rules on your plan. If you are still actively employed by the 401K plan provider, there probably are restrictions on withdrawals (called an in-service withdrawal).

As far as moving money from your 401K into Roth, there is nothing special or pressing about the 60 day window to replace the withdrawal you've made. If you have no restrictions on in-service withdrawals, You can choose to Roth convert as much of your 401K as you want, when you want, as long as you pay taxes on it. You should do some tax planning for your retirement future and see when you expect lower tax rate opportunities to Roth convert in your future. 

Taking a HELOC to put the money back in the Roth depends on the interest rate compared to what you expect to earn on Roth invested money. A Roth is a great vehicle, but a lot of the advantage comes from tax free compounding over long periods of time. Some of the advantage of Roth diminishes relative to regular taxable savings as you get older. Be sure to factor that into the decision to take out a loan.

[iced]

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@phxphun wrote:

Up front, I realize the best answer to our question is "see a retirement planner or tax specialist".   And we do now have an appointment with one.  Unfortunatley, we weren't able to get in to see one before the now approaching 60-day deadline that will end our ability to deposit money back into the Roth IRA we took it out of and avoid paying taxes on it.  

My husband has a Roth IRA, I have a 401k.  We were faced with a large emergency need, so we took a $40K distribution from his Roth and would like to re-deposit that $40K within the next 20 days to avoid paying tax on it - and because we believe that's the better place to save toward retirement.    

We're both just over 59 1/2  years old.  My 401k is strong toward our overall retirement plan.  We have $400K equity in our home valued at $720K.  Our credit scores are both 810+.

So our options to get the money back into the Roth are to take the $40K out of my 401k or take out a home equity line of credit.   We'd pay 26% taxes on the 401k distribution and we'd lose any future growth potential on it.  On the other hand, we'd pay interest on the HELOC and we aren't certain we'll be in the house more than a few more years. 

In general, is one of these clearly a more overall effective way to go? Any pitfalls to be aware of?

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If you're over 59.5, the Roth should be tax-free withdrawal. You'll still have the opportunity loss since if you don't repay it those funds can never grow tax-free again.

The deciding factor here for me is how soon would you start tapping that Roth anyway. If you weren't going to touch it until you were in your 80s, then the HELOC repayment and eating the interest is very likely going to win out for you. If you were going to start taking distributions in 5 years, then you don't really lose that much opportunity on the $40k, and depending on the interest rate of your HELOC, may be a wash or even a loss to go the HELOC route.

[tacpoly]

I’m a bit confused:

1. If your husband was 59.5 years old when he withdrew $40k from his Roth, then you should not owe any tax provided he’s had the Roth for 5 years or more.

2. Therefore you do not need to redeposit the money to “avoid paying tax on it”.

3. If you want to redeposit the money to continue to take advantage of tax-free growth and withdrawal of your investment, if you need to withdraw from your 401k to do that, then you’ll have to calculate how much return you’ll need to make (for the timeframe you have) for it to be worthwhile because of that initial tax hit.

If you want to put your money in a Roth, perhaps consider putting future contributions in a Roth 401k instead. With the contribution limit plus catch-up, it will take less than a year to contribute $40k in if you and your husband both do it.

[phxphun]

Thank you bada_bing. 

(Note - I was mistaken in saying we wanted to put the $40K back into Roth to avoid taxes on it.  We only want it back for the sake of growth in a Roth). 

We've already taken the in-service withdrawal without penalty.  There was no restriction on the initial withdrawal due to our age being over 59.5.  I'm checking on what other restrictions there may be with regard to rolling some of the 401k to cover the Roth withdrawal (and maybe some additional).  

Yes, now that I better understand the immediate issue, at this point we'll get with a retirement planner.   

[phxphun]

Thank you iced.

Yes, I was mistaken in saying we wanted to put the $40K back into Roth to avoid taxes on it.  We only want it back for the sake of growth in a Roth. 

The Roth value is now less than one-tenth that of the 401k.  We'll also have a pension and two social security incomes.  So, potentially we wouldn't need to touch the Roth until our 80's. 

I appreciate having your perspective on it.  Makes sense to me.     

[phxphun]

Thank you tacpoly.

I was mistaken in saying we wanted to put the $40K back into Roth to avoid taxes on it.  We only want it back for the sake of growth in a Roth. 

Now that I realize the 60-day requirement doesn't really have much meaning, we can take some time to look more closely at how we're funding both accounts - and meet with an advisor.   Thank you for that advise. 

[Save-n-Invest]

If the Roth IRA was a conversion from a traditional IRA here is a five year rule before taking funds.

https://www.fidelity.com/insights/retirement/roth-ira-five-year-rule