Author Topic: Penalty loopholes for 401K and IRA  (Read 3712 times)


  • 5 O'Clock Shadow
  • *
  • Posts: 24
  • Age: 43
  • Location: Madison, WI
Penalty loopholes for 401K and IRA
« on: August 13, 2014, 09:40:17 AM »
The Roth IRA loophole discussed in this post is intriguing to me.  Hoping someone can share first-hand experience using this method.
Some specific questions/concerns on it:
- Are there any snags or downsides not mentioned in the post?
- If it's a loophole now, couldn't the government change it (close the loophole) in the future?
- Does this method work with IRA --> Roth rollovers as well or just 401K?
    Build up your 401k and any other savings, then quit your job to begin retirement hooray!
    You are now in a low tax bracket you can actually roll over a chunk of your 401k into a Roth IRA account and pay income taxes on it at this point.
    Then you let it sit in the Roth IRA for a minimum of 5 years
    At this point, you can withdraw all of the principal (but not the gains yet, no big deal), penalty-free!


  • Bristles
  • ***
  • Posts: 425
Re: Penalty loopholes for 401K and IRA
« Reply #1 on: August 13, 2014, 01:24:54 PM »

-Possible factors you might not be thinking about is income from any taxable investments you're holding. The conversion strategy works because you don't have income, thus recharacterizing 401k doesn't cost you taxes as long as you stay under a certain threshold (standard+exemption deductions). You can also opt to pay 15% tax, which I think let's you recharacterize up to 90k when you're filing joint married
-Downside is that you have to be really organized and be able to track your windows correctly so as to not incur penalties from withdrawing Roth too early (have to wait five years for each tranche you recharacterize/convert)
-It's not really a loophole, if you're managing your finances smartly by saving and investing, that's behavior that the government wants to ENCOURAGE, not punish
-You can recharacterize IRA just like a 401k, in fact, (correct me if I'm wrong), I believe you have to roll your 401k into an IRA before you can recharacterize

Here's an advanced strategy, recharacterize several different tranches, then switch the ones that don't do as well back to non-roth before the end of the year:


  • Magnum Stache
  • ******
  • Posts: 4427
  • Location: CT
Re: Penalty loopholes for 401K and IRA
« Reply #2 on: August 13, 2014, 01:29:00 PM »
I will start with the caveat that I have never done it yet but have researched how to do it with the correct forms and taxes.

Snags or downsides - if you don't grok taxes you should before shooting for this strategy.

Can the government end the foundation of this strategy? Yes. Yes they can. The question is will they? Probably not as either way they get the taxes. There is no incentive currently to eliminate this. This also brings up my private quibble with calling it a loophole. "An ambiguity or inadequacy in the law or a set of rules." This is neither of those. It is not ambiguous it is quite well mapped out. It is not a loophole but a function of our tax system, this is also not a case of a defect being a feature. It is in the design.

Does this method work with IRA to Roth IRA? Yes. In fact you should roll over your 401k to an IRA first, MMM glossed over this step but it is one of the steps.