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From the EOB, "If the participant has an outstanding loan at the time of death, the participant's death will usually result in an offset of the unpaid balance against the accrued benefit. The participant (or the participant's estate), not the beneficiary, will be liable for any taxes resulting from that offset, because the beneficiary is not a party to the loan agreement. The tax liability might be reported on the participant's final income tax return or on the estate's income tax return." Above from EOB Chapter 7, Section XIV Part I It also references Treas. Reg. Section 1.72(p)-1 for taxation of loan offsets. I also found that 72(t)(2)(A)(ii) provides an exception to the early withdrawal penalty for distributions made to a beneficiary (or to the estate of the employee) on or after the death of the employee. Hope this helps!