401(k) loan outstanding at death

[Bruce Steiner]

An unmarried participant in a 401(k) plan had a loan outstanding at her death. She did not name a beneficiary, and under the terms of the plan, the default beneficiary was her estate. Most (though not all) of her account consisted of appreciated employer securities.

Soon after her death, the plan treated the loan as being in default, and issued a Form 1099 in her name (not in the name of the estate).

1. What generally happens upon the death of a participant with an outstanding loan?

2. How does this affect the requirement of a lump sum distribution in order to elect NUA treatment?

[Guest P A Weick]

Under our plan loan documents the death of a participant is an event of default. We then treat the loan as defaulted and would report it as a deemed distribution.

The fact that it is a deemed distribution does not make it a distribution for purposes of Section 402. See Q&A 12 of the final plan loans regulations issued in 2000. So maybe you can still do a lump sum distribution to protect the NUA.

What I am struggling with on a death we just learned of is whether the deemed distribution should be reported as taxable to the decedent, his estate or the beneficiary.

Any thoughts would be appreciated.