I'm trying to determine how practioners handle situations where a participant takes out a loan and then dies before it is repaid.

Does your loan policy state that the loan will automatically go into default?

In our loan documents, death does trigger a default.

How can death not trigger a default?

Death does not necessarily trigger default. If the participant has an outstanding loan balance (secured by his/her account) at the time of death, the loan is offset against the participant’s account balance…not sure what happens if the loan is not secure by the account balance

I'm probably missing something, but doesn't the default trigger the offset. I realize that the offset and the default may not occur at the same time, but why would there be an offset if there is no default?

Death triggers the offset.

Default does not trigger offset.
Default triggers deemed distribution, which ,as you know is treated differently , administratively, from offset

Why is death a different distribution event for a loan than termination of employment?

I disagree. The default is the reason for the offset. The offset can't occur until a distributable event, i.e. death, but if we say there is no default than there is no reason to offset.

We believe the estate of the deceased participant can repay the loan to avoid the offset and resulting Form 1099-R in the decedent's name.

Our situation was a non-spouse beneficiary of a wealthy participant who died with a loan balance due of over $40,000.

The family's attorney is considering whether or not the estate should repay the loan.

Any thoughts out there?

ljr:

Whether the estate can repay the loan depends on the terms of the loan. The estate has no independent right to be able to repay the loan if the loan documents would preclude it.

Could some one explain the financial advantage of repaying the loan with after tax dollars? If the taxpayer was in the 32% tax bracket there would be a tax of $12,800 due on the phantom income. That is $27,200 less the $40,000 in cash needed to repay the loan, assuming that an estate can repay the loan (which I dont believe is possible under the terms of the note). The 27,200 saved by paying the tax on the phantom income can be invested in capital assets which will generate capital gain at a rate of no more than 20%. Both the $40,000 invested in the plan and earnings will be subject to income tax at a higher marginal rate.

This seems to suggest that death triggers an offset

QUOTE (yvonne001 @ Feb 21 2003, 06:33 PM)





Quoted from this thread <a href='http://www.benefitslink.com/boards/index.php?act=ST&f=17&t=18623&hl=loan,and,death,and,deemed'>http://www.benefitslink.com/boards/index.p...eath,and,deemed</a>

Any comments- I have a similar issue- except that the loan is in default

I dont know where the ERISA outline book gets the authority for such a statement. If death is a default event then the amount of the loan balance will be considered a distribution to the beneficary as sucessor in interest to the participant. Reg. 1.72(p)-1 Q 4. Since distributions from a qualfied plan are income in respect of decedent under IRC 691 the beneficary will be taxed on the amount of the distribution. The participant's tax final return includes those items of income paid up to the date of death. Amounts paid to the participant after death are taxed to the estate. If the participant's account balance includes the loan then the loan is an asset of the account and the beneficiary becomes the owner upon the death of the owner. I would be interested in how TPAs report such distributions.

My initial reaction was similar to yours mbozek …but I did some digging and it appears that the ERISA Outline is right…this seems to be one of the exceptions to the rules you state above … Treas Reg § 1.401(a)-20 , Q & A 24(d)

A: Interesting cite but I am not sure it answers the question of who is taxed on the outstanding loan balance since death benefits are taxed as IRD under IRC 691. Q-24(d) merely recites that the accrued benefit due the spouse under a plan is reduced by the amount of the outstanding loan.

I can understand that POV... The problem is 1.401(a)-20 , Q & A 24(d) does not specifically state to whom/what the outstanding loan balance should be taxable. IMHO, if the benefit due to the spouse is reduced by the outstanding loan balance , then another party must be responsible for the outstanding loan balance . The only other person involved in the equation is the deceased. Also , it seems to make sense to report it to the deceased since it was the deceased who received the funds. Treating the amount as an offset (reportable) is merely adjusting the transaction type ( for lack of a better expression) for assets which were already received by the deceased… if you receive funds as a loan and the loan is in default or is offset against your balance when applicable, then the amount should be reported to you- the person who received the loan. The amount then should be reported on the final tax return of the deceased