Dead guy with an outstanding loan

[MSN]

Participant dies with an outstanding loan of about $3,000. The total account balance, including loan balance) is only $3,500. The sole beneficiary (non-spouse) elects a cash distribution.

Is the entire $3,500 taxable to the beneficiary? Or, is the outstanding loan balance taxable to the decedent and the remaining balance taxable to the beneficiary.

Any help with this situation would be appreciated!

[Appleby]

All I could find was something on plans with QJSA or QPSA. But I think the interpretation also applies to plans not subject to QJSA or QPSA.

According to IRC §401(a)(11)(B)(iii) & Treas. Reg. §1.401(a)-20, Q&A-24(d), the loan is not included in the amount paid to the beneficiary.

[Bird]

I'm pretty sure the loan balance is taxed to the estate and the beneficiary gets a 1099-R for what she actually received. It's the only thing that makes sense, really.

[jpod]

Putting aside tax questions, what is it in the plan document or loan documents that relieves the estate from having to repay the loan balance to the plan, for the benefit of the beneficiary? Is the beneficiary entitled to the note as part of the account balance and as a result she has a claim against the estate? Or, is there something in the documentation that states that the loan balance is "foregiven" upon death? This may or may not be academic question from the beneficiary's perspective, depending upon how the participant's will is drawn and/or where the beneficiary stands as the participant's heir.

[Bird]

Putting aside tax questions, what is it in the plan document or loan documents that relieves the estate from having to repay the loan balance to the plan, for the benefit of the beneficiary?

Our loan policies have this clause:

If a Participant has an outstanding balance remaining on a loan and the Participant (or the Participant's spouse or beneficiary) is entitled to a payment from the Trust Fund before the loan is repaid in full, the Trustee will offset at the time of distribution the unpaid loan balance (including accrued interest) from the total amount otherwise due.

The individual loan agreements have something similar.

I see what you're getting at; a beneficiary of the plan might prefer to receive a note rather than a reduced payment if s/he is not the beneficiary of the estate. I think the reason that can't happen is that the loan is not transferable to another party; it can only be between the participant and the plan.

[jpod]

I wasn't suggesting that the loan is transferable. What I was suggesting is that absent language like yours, the participant's estate remains liable for his debts, and the note is an asset of the plan account just like any other assets. If the account is distributed to the beneficiary, the note is distributable to her and she can go after the estate.

[masteff]

Plan language would be very important. Are loans automatically offset upon death and/or upon full distribution? Are distributions limited to cash only? Etc.

[Guest mjb]

Can some one explain where the right to sue comes from. The beneficary of the participant is attempting to sue the estate of the participant for a loan the participant took out against his own account, i.e., he borrowed the funds from himself. Isnt the beneficary attempting to sue himself since the beneficiary stands in the shoes of the participant and has only the rights that the participant would have. Why is a loan from a qual plan any different from a loan that the owner of a LI policy takes out against the cash value of the policy.

[MSN]

Good to see this wasn't as obvious an answer as I thought it might be.

In this case, the loan policy states the loan is offset on the participants death. This would seem to indicate that the estate should be responsible for the taxes, but I also see jpod's point that this has the effect of shortchanging the beneficiary. Could the beneficiary file a claim for benefits from the estate for the balance of the unpaid loan? I wouldn't think the bene would have recourse against the plan, but could be wrong...

[Bird]

jpod, I'm missing something. How can you say the loan is not transferable and also say it could be distributed?

As a general rule, loans are from the plan and the participant's account is collateral. When a distributable event occurs, the collateral is claimed as an offset. It just can't be any other way - there is some concern being expressed for the beneficiary losing out on part of what he is supposedly entitled to, but think of the alternative - the bene gets the loan, and is taxed on it, and can't collect. That just can't happen.

[masteff]

the loan policy states the loan is offset on the participants death

I'd take that to mean the offset is taxable to the decedent.

[jpod]

Bird: If the loan is offset on the participant's death, which is the result of good drafting, that means it's foregiven. In that case, that's the end of the story. If the loan is not foregiven at death, the decedant's estate is liable to the plan for the debt.

MJB: What is the basis for the theory that the beneficiary "stands in the shoes" of the participant? To ask the question differently, why would the estate not have an outstanding debt to the plan if the documentation does not provide for loan foregiveness at death?

[Bird]

jpod, I understand now what you were saying. I guess I have to let it go at hoping I never have a situation where the document wasn't drafted properly. Ultimately I don't think the loan can be distributed but I can't prove it.

[Guest mjb]

MJB: What is the basis for the theory that the beneficiary "stands in the shoes" of the participant? To ask the question differently, why would the estate not have an outstanding debt to the plan if the documentation does not provide for loan foregiveness at death?

JPOD: You still have not answered my Q as to why a beneficary's rights to retirement benefits which are subject to an outstanding loan from a Q plan are treated differently from a beneficary's right to proceeds under a LI policy which are reduced by a loan taken out by the owner of a LI policy. Please explain.

[Bird]

JPOD: You still have not answered my Q as to why a beneficary's rights to retirement benefits which are subject to an outstanding loan from a Q plan are treated differently from a beneficary's right to proceeds under a LI policy which are reduced by a loan taken out by the owner of a LI policy. Please explain.

Isn't the onus on you to prove why these two unrelated matters should be treated the same? I happen to agree that they should be, but I don't know of any legal reason why, and would like to be educated.

[jpod]

mjb: I don't know what the rights of a death beneficiary are under a LI policy upon the death of the insured when there is a loan outstanding, but I assume whatever they are they are governed by the terms of the contract. But why is that pertinent to the issue at hand? Unless the QP loan is foregiven at death, isn't the note, or the receivable, or whatever you wish to call it, an asset of the decedent's QP account which then becomes distributable to the beneficiary?

[Steelerfan]

I can't imagine a plan that doesn't require the loan to be paid in full or deducted from the payment at distribution. I would think it would be executor's responsibility to pay the debt of the estate prior to distribution, otherwise the beneficiary would have to recover from the assets of the estate. If there are not enough assets, the bene would be out of luck, I guess. There is probably a way for the beneficiary to become a creditor of the decedent even if he/she is not an heir or legatee, but it shouldn't get that far if the estate can pay. But I'm not an expert in this area.