401k Advice

[jmbskyz]

Client is a female in her late 20's who has a 401k with her current employer, but no longer contributing. She really does not want this 401k any more and is interested in obtaining life insurance. She would like to take the 10K that is in her 401k and use it to purchase a life insurance policy.
I am not familiar with the tax consequences of doing such a transaction and would like the opinion of fellow agents and your possible recommendations for this client.

 

[Justin Bilyj]

She will pay the penalty tax of 10% because of her age. She will also pay taxes on the full amount she takes out at her marginal tax rate.

So depending on how much she makes, she could be paying 40% in taxes.
Why does she want the life insurance? Is it term? GUL? WL or Par? If its term, can she convert it?

 

[axeman462]

She would have to pay a tax penalty.
But I feel doings this wouldn't be in her best interest. Have you considered rolling the 401k into an annuity and letting it grow, and then putting her into a cheap term policy?

 

[DHK]

If she is still WITH her current employer, then she can only touch it via 401k loan, IRS Qualified Hardship, or through an in-service distribution rollover to an IRA.

You cannot rollover a 401k balance from a current employer into an individual IRA.

401k loans are available for personal use, or for purchasing a home. They are "tax & penalty free", but you pay them back with after-tax dollars out of your current paycheck. In addition, if she leaves her current employer while she has an outstanding loan balance, it is to be paid in full within 60 days, or the entire remaining balance is subject to taxation and penalties.

 

[Justin Bilyj]

DHK correct me if I am wrong, but most loans (besides a mortgage) have very short repayment terms, no?

 

[DHK]

Personal use loans have a maximum repayment period of 5 years. Residential loans (I think) are 10 years, but isn't specified by the IRS.

401(k) Resource Guide - Plan Sponsors - General Distribution Rules

Loans from 401(k) plans. Some 401(k) plans permit participants to borrow from the plan. The plan document must specify if loans are permitted. A loan from the 401(k) plan is not taxable if it meets the criteria below.

Generally, if permitted by the plan, a participant may borrow up to 50% of his or her vested account balance up to a maximum of $50,000. The loan must be repaid within 5 years, unless the loan is used to buy the participant’s main home. The loan repayments must be made in substantially level payments, at least quarterly, over the life of the loan.

The participant must reduce the $50,000 amount, above, if he or she already had an outstanding loan from the plan (or any other plan of the employer or related employer) during the 1-year period ending the day before the loan. The amount of the reduction is the participant’s highest outstanding loan balance during that period minus the outstanding balance on the date of the new loan.
Certain participant loans may be treated as taxable distributions. For more information, refer to the section, “Loans Treated as Distributions,” in Publication 575.

 

[Norwayguy]

Client is a female in her late 20's who has a 401k with her current employer, but no longer contributing. She really does not want this 401k any more and is interested in obtaining life insurance. She would like to take the 10K that is in her 401k and use it to purchase a life insurance policy.
I am not familiar with the tax consequences of doing such a transaction and would like the opinion of fellow agents and your possible recommendations for this client.

If she is still employed with this employer she will most likely not be able to take a distribution other than a loan or hardship distribution.

 

[jmhalvo]

Client is a female in her late 20's who has a 401k with her current employer, but no longer contributing. She really does not want this 401k any more and is interested in obtaining life insurance. She would like to take the 10K that is in her 401k and use it to purchase a life insurance policy. I am not familiar with the tax consequences of doing such a transaction and would like the opinion of fellow agents and your possible recommendations for this client.

totally horrible idea

 

[sman]

Client is a female in her late 20's who has a 401k with her current employer, but no longer contributing. She really does not want this 401k any more and is interested in obtaining life insurance. She would like to take the 10K that is in her 401k and use it to purchase a life insurance policy. I am not familiar with the tax consequences of doing such a transaction and would like the opinion of fellow agents and your possible recommendations for this client.

As has been stated, a terrible idea. I would recommend you learn the laws surrounding qualified plan distributions so you can be prepared when something like this arises.

Just out of curiosity, where did this client get the idea of possibly using her 401k to fund life insurance?

 

[G5reality]

She can Roll the 401k into an Individual 401k or self directed IRA and invest in wherever she wants, (if no longer employed).


I would absolutely show her what the same money would do in a UL or Indexed UL policy and urge her to make future contributions to the Policy.