Plan participant dies with an outstanding loan

[Guest yvonne001]

A participant in a 401K plan died and had an outstanding loan. I have a few questions about how to handle this. Her husband is also a participant in the plan and wishes to roll her account balance over. He does not want to pay off the loan. He also wants the least tax liability. If the loan is deemed a distribution at the participant's death then the 1099-R is issued under her name because it was her loan. How would I code the 1099? 4 & L? What if any tax penalties would apply? I have never had this happen before and would appreciate any help.

I almost forgot to ask, do I need to withhold taxes from her account before her husband rolls it over? Thanks.

[maverick]

If the plan accepts rollovers, and allows loans to be rolled in, you shouldn't have any problems. A 1099-R would be issued to the deceased spouse under code H (rollover into a qualified plan).

[Guest yvonne001]

He doesn't want to pay the loan off or make payments on the loan. Don't I need to issue a 1099 under her name for the balance of the loan?

[mbozek]

Since a participant can rollover a loan to another qualified plan, and a surviving spouse can rollover a distribution of the decedent spouse interest to a qualified plan, why cant the surviving spouse rollover the loan with the rest of the deceased spouse's account balance to his account? Why not just assign the loan to the H and continue the loan repayment? H as assignee could continue to pay it off through his account. Second option- Why cant H take out a loan from his account and use the proceeds to pay off W's loan? H could roll over W's account balance to his own account if necessary to have sufficient assets to use for the loan. Need to check the plan of course and avoid defaulting on repayment.

[Guest yvonne001]

The husband does not want to pay the loan payments at all. His wife had cancer and he has major medical bills to pay and can't afford to make payments on the loan.

[Guest b2kates]

Are you saying the surviving spouse will not be making any loan payments. If so, then to distribute account balance, you will need to offset the loan.

This will result in tax consequences to the surviving spouse.

At minimum you are faced with an anticipatory breach of the loan agreement.

[Guest yvonne001]

The ERISA Outline book 2002 edition says "If a 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..... The plan's loan policy might allow the beneficiary to assume the loan obligation and make repayment. A surviving spouse might do this, for example, in order to repay the loan and increase the amount available for rollover by the surviving spouse."

I guess that's why I'm questioning how to code a 1099 to the participant and what taxes need to come out of her account before it is rolled to her spouses account.

[E as in ERISA]

My guess: Code the 1099-R as "4" -- for death. I don't think "L" applies because it an actual distribution (in the form of a offset) not deemed distribution. She didn't violate the rules or default. She had a distribution event (death) and an offset occurred. If no cash is distributed at the time of offset, then withholding is generally not required. However, when the return is filed, there will be regular tax paid on the offset reported as a taxable distribution. There shouldn't be any 10% additional tax, because death is an exception.

[Guest yvonne001]

Thanks.

I am reading in the instructions for filing the 1099 and the code 4 says to use regardless of the age of the employee/taxpayer to indicate payment to a decedent's beneficiary including an estate or trust. Now I'm not sure if 4 is the right code. I keep second-guessing myself. Any reassurance?