Can a 401k loan from a family member count as a gift?

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  • #71496
    F_Perkins
    Participant

    Can a family member take out a 401k loan and give the money to me as a gift toward my MRF? (The gift would not need to be paid back by me.) She would take a loan instead of a withdrawal in order to avoid the 10% 401k withdrawal penalty; as well as the tax penalty.

    #71498
    Nelsont
    Member

    As long as it’s a gift you can write a letter of explanation and they can write a letter of explanation and you can have the money in your bank account before you make an offer you should be fine. The question is depending on how much the amount is whether they should be doing this.

    #71500
    F_Perkins
    Participant

    The amount would be $25,000. How would that affect us?

    #71501
    Nelsont
    Member

    Whether it’s 1 or 1 million the process is the same.

    The question is really whether your gifter can afford to be doing this. Some plans allow a loan for a mortgage to be repaid over 10 years but the loan holder needs to be the mortgage applicant and in most cases the mortgage application needs to be approved by the 401k provider which is exactly the opposite of the naca requirement of having the money already transferred before you are allowed to see the mortgage application. Because of this it is much more likely your gifter would need to take out a 401k loan for personal reasons which comes with 1 to 5 year repayment plans depending on the servicer. That means your gifter will have a paycheck that is roughly 200 to 400 dollars less than normal every pay period for up to about 5 years. And keep in mind 401k plans are unique to employers so that loan is only good while your gifter works at their current company. If your gifter gets a new job at a new company in the next 5 years that loan becomes an early disbursement unless they are 59.5 years old and a full lump sum repayment will be required within 90 days or a 10% penalty is added to the following years tax return plus the remaining balance of the unpaid loan becomes adjusted gross income that they never paid taxes on. So if they were looking hypothetically to get a $2000 return they might be hit with owing 1000 instead. And then add in the fact that 25000 over 5 years could turn into 100000 in savings if it wasn’t touched. It’s a lot to think about.

    #71530
    F_Perkins
    Participant

    Hmm… that IS a lot to think about.

    If she still wishes to gift us the money, would it be considered an allowable gift from her? Or would it be ungiftable because it was a loan (even though technically it is her money).

    #71531
    TTrumble
    Member

    Hello F_Perkins,

    The gift would be allowable, but only on the narrowest of technicalities, to which you referred. Even then, it’s still not a good idea.

    Borrowed funds are not allowed to be used as buy-down funds, even gifted borrowed funds since there may actually be an under-the-table agreement to pay it back to the person giving the gift. However, 401k funds are in fact already the borrower’s funds, and technically it’s impossible to borrow from yourself.

    The caveat here though is the tax implications for the borrower/gifter if they don’t pay it back. The money will automatically become taxable income, plus the IRS will hit it with a 10% early withdrawal penalty. Therefore, the $25,000 could cost them and additional $8,500 if they’re in the 24% tax bracket and a whopping $12,000 if they are in the 38% tax bracket.

    If they run into trouble paying it back, who do you think they will come looking to for some help? And the moment you give them one dollar, it puts you in violation of your membership agreement with NACA.

    Give it lots of thought before you act.

    Tim Trumble
    Online Operations, NACA
    ttrumbel@naca.com

    • This reply was modified 3 months, 1 week ago by TTrumble.
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