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Asset Sale, New Employer plan, Loan offset


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This client sold his business, it was absorbed by a larger company.  Almost all of the employees went to work for the new owner.  

Many employees are rolling their pension accounts into the new employer's plan, some into IRAs.  One employee has a loan and would like to "cancel it out" and only roll over her tangible assets to the new employer's plan.  Am I missing anything... any reason she can't do this?  Split her distribution into 2 parts, rollover to new plan and cash distribute her loan as a taxable distribution?

Thanks

Its not easy being green

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  • 4 weeks later...

Excuse the senior moment.  Same situation, plan is terminating, all employees working for new employer.  One participant has a loan outstanding.  Since the plan is terminating, and the participant can not repay at the moment, isn't the outstanding balance offset from his account balance?  let's say he has a $14,000 account balance plus an outstanding loan balance of $3,000; total account balance $17,000.  Is not the $3,000 offset against  the total account balance of $17,000, in effect meaning the loan is "forgiven".  What am I missing here?

I advise my clients not to offer loans.

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My understanding is if the Plan if Terminated and the loan is offset then it is a Qualified Plan Loan Offset.

The $3,000 would be taxable in the year offset with 1099-R issued with code 1M, 2M, or 7M depending on the participant's circumstances. The participant would have until October 15 of the year following the offset to roll the amount to an IRA or include it in income in the year of the offset.

From IRS instructions - Use Code M for a qualified plan loan offset (which is generally a type of plan loan offset due to severance from employment or termination of the plan).

 

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This plan is terminating, the employees are terminating employment with the seller and will be employed by the buyer on the date of sale.

My reading of the QPLO proposed regulations amending 402(c)(3) is that the outstanding loan balance is an eligible plan rollover simply because the participant and the plan have terminated.  The proposed regs do not mention that the participant must be BOTH over 59 ½ as well as a terminated participant/plan is terminating.(I'm not an attorney, so of course I could be wrong).  This would suggest that the participant, whose total account balance consists of the investment account plus the loan, let's say is $17,000 (loan outstanding of $3,000 plus investment portion $10,000), since the loan is a QPLO because both participant and plan are terminating, the loan balance is an eligible rollover distribution, which can also be rolled over.  I do not see how the $3,000 outstanding loan balance could be taxable if he's is rolling over.

Am I missing something?

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If he is rolling the loan to the new plan and the new plan accepts the rollover of the loan, sure it's a rollover and not an offset. But not every plan will take participant loan in kind as a rollover asset.

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Perhaps incorrectly but I read the wording that if the amount of the loan offset ie the outstanding balance of the loan, is rolled over to an IRA or another employer's plan - not speaking of an in-kind transfer of the loan- the loan in effect would be cancelled, but then again, how can you rollover a loan amount that is not part of the account balance?

in my example above, does not that mean he rolls over the full $17,000 and the loan is in effect, cancelled as you can't rollover money that is not in the plan?

Or am I totally off base and reading incorrectly?

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On 5/20/2022 at 10:20 AM, thepensionmaven said:

Perhaps incorrectly but I read the wording that if the amount of the loan offset ie the outstanding balance of the loan, is rolled over to an IRA or another employer's plan - not speaking of an in-kind transfer of the loan- the loan in effect would be cancelled, but then again, how can you rollover a loan amount that is not part of the account balance?

in my example above, does not that mean he rolls over the full $17,000 and the loan is in effect, cancelled as you can't rollover money that is not in the plan?

Or am I totally off base and reading incorrectly?

The participant received $3,000 in taxable income in the form of a loan offset, which is basically loan forgiveness. If they want to defer taxation on that, then they need to recontribute that amount to an IRA or another plan. It's true that no cash distributed to them at the time of the offset, but that doesn't matter. They need to come up with $3,000 for the rollover, or pay tax on it.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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10 minutes ago, thepensionmaven said:

Participant wants to pay off the loan by reducing his account balance by the amount of the outstanding loan.  Is there a cite that mentions this can or can not be done?

You could but there is absolutely no point to it. It will end up in exactly the same situation as if you just took the taxable offset.

Situation 1: Direct rollover of $14,000 to IRA, loan offset of $3,000. Amount in IRA: $14,000. Taxable income: $3,000.

Situation 2: Take cash distribution of $3,000 and roll over the remaining $11,000. Use the $3,000 cash to repay the loan. Now there is $3,000 in the 401(k) plan from the loan repayment, so roll that over to the IRA. Amount in IRA: $11,000 + $3,000 = $14,000. Taxable income: $3,000 from the cash distribution. Note in this case the cash distribution would have mandatory 20% withholding applied, so the participant would have only received $2,400 cash and would have to come up with the extra $600 out of pocket in order to fully repay the loan. It wouldn't change the outcome though.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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Perhaps I am misreading, or just plain not familiar, but § 1.402(c)-2, Q&A-3 seems to say the distribution of a loan offset amount is an eligible rollover distribution and    Section 1.402(c)-2, Q&A-9(b),the accrued benefit is reduced by the amount of the loan offset in the event of the employees' termination of employment.

The employee is terminating employment and will be working for the purchaser of the company as well as  the current plan will be terminated. Reading 402(c)(3)(C)(ii) as well as Section 1.402(c)-3(a)(2)(iii)(B) of the QPLO proposed regulations, it  would appear that, due to this circumstance, the loan is a QPLO and would be treated as an eligible rollover (and not taxable as his account balance is being reduced by the amount of the outstanding loan balance.

If the above does occur, I don't see anything that states the rollover distribution (account balance less outstanding loan).

Or are we saying the reduced account balance does not obviate the taxable loan balance and the only way this would be non-taxable is to have the buyer's plan accept the loan? 

 

 

 

 

 

 

 

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22 hours ago, thepensionmaven said:

If the above does occur, I don't see anything that states the rollover distribution (account balance less outstanding loan).

You're missing some words there.

22 hours ago, thepensionmaven said:

Or are we saying the reduced account balance does not obviate the taxable loan balance and the only way this would be non-taxable is to have the buyer's plan accept the loan? 

Yes (or roll it to an IRA).  The loan is indeed an eligible rollover, but if it's not rolled over, it is effectively distributed and therefore taxable. Under no circumstance does it simply go away.

Ed Snyder

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