Dear Dr. Don,

I have a 401(k) account with a prior employer. If I want to take a 401(k) loan out against it, can I do so, even though I am no longer employed by that company and don’t currently make contributions to it? If so, would I have to leave the money with that company until the loan is paid back? Or, can I roll over the balance into a Roth IRA account?

— Colleen Convoluted

Dear Colleen,

The 401(k) plan document would have to allow for this type of loan and I’m not aware of any that do. Still, it wouldn’t hurt to speak with the plan provider.

The typical 401(k) plan doesn’t allow a loan after the employee has stopped working for the employer. In fact, any outstanding loans at termination of service quickly become due — usually within 60 days. This makes sense, because the funding source for loan payments — the employee’s paycheck — has stopped.

I’m going to assume all of the money in your employer’s plan is held in a 401(k) and not a Roth 401(k) account. I’ll further assume that you don’t have any of the employer’s stock in your account. If neither of these assumptions is correct, you’ll need to ask your question again.

Rolling the money into a traditional IRA by means of a direct transfer would continue the tax deferral of the funds. Rolling the money into a Roth IRA would trigger income taxes on the rollover, but the money would then grow tax-free. You can’t borrow against a traditional or Roth IRA account, other than the use of the funds for 60 days permitted periodically when moving money from one IRA account to another. This is discussed in IRS Publication 590, Individual Retirement Arrangements.

You do have 60 days to roll the money from your 401(k) plan into a traditional IRA or Roth IRA. But when the 401(k) plan cuts a check to you, it’s known as an indirect transfer, and the plan will subject the distribution to 20 percent mandatory withholding. Fully funding the account will require you to come up with the 20 percent from another funding source. This isn’t the answer for a short-term loan.

In the end, I don’t see an easy way for you to borrow from the account. The advisability of rolling the monies into a Roth IRA is something better left to you and your tax professional.

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