Can death beneficiary's IRA hold deceased EE's participant loan as an asset?

[J Simmons]

401k participant who had a participant loan partially repaid died. He had designated as his beneficiaries his surviving (second) spouse 50% and his only child (from prior marriage) the other 50%. Both death beneficiaries are planning on having a direct rollover of their respective death benefits to IRAs.

The deceased participant's estate is now the debtor on the loan. The estate is cash strapped, and will be for quite some time.

Where the debtor on the loan is the Estate and the owner's of the IRAs would be the spouse and the child "as beneficiary of" the deceased participant, may the IRAs be assigned 50% each of the promissory note that the Estate is now obligated to pay?

[Bird]

Doesn't the loan simply become a taxable distribution to the estate at death?

[J Simmons]

Doesn't the loan simply become a taxable distribution to the estate at death?

It would if the Estate was the death beneficiary as well as the obligor on the note.

It isn't. The participant died intestate in a community property state; all of his assets will go to surviving spouse. The daughter from an earlier marriage wants her 1/2 of the value of the note ($20,000 being 1/2 of the approx $40,000 balance on the note). The daughter thus wants her 1/2 of the note held by the plan trust assigned to her, and rolled into an IRA along with 1/2 of the other plan benefits.

The spouse, on the other hand, wants her 1/2 of the note held by the plan assigned to an IRA in her name.

While the decedent's estate currently has more debt than assets, the estate has a couple of receivables that will not be due for another couple of years.

In essence, the daughter is not willing to lose her $20,000 interest in the promissory note in exchange merely for the Estate paying the income taxes on it.

[Belgarath]

I'm confused as well - thinking more along the lines of Bird. Does the plan provide that upon death, the account balance is reduced by the outstanding loan? If so, then does this question become moot?

[J Simmons]

If the estate of the participant was the death beneficiary as well as the new, successor obligor on the loan, then on distribution of the other death benefits, the loan would be forgiven and the estate would be taxed on the value of the forgiven loan as well as the other death benefits distributed. You get to the same place from the estate's perspective and the plan's as if the estate paid the loan off and then all the death benefits were paid to the estate.

Here, however, the obligation passed from the decedent to his estate upon his death, but the benefits pass by specific designation to his wife (2nd one) and his daughter by the first marriage, 50-50. So we do not have identity between who is obligated on the note and who owns it as an asset. For example, if the estate paid it off, that would all reduce the amount of the ultimate net estate going to wife #2. The plan would then have $40,000 more, and only 50% of that would go back to wife #2. The other $20,000 would go to the daughter.

If the plan simply retired the loan in favor of the estate, the daughter would be shorted $20,000 of her 50% of the death benefits and wife #2 get that $20,000 in addition to her full 50% of the death benefits.

So, I'm back to my questions. Does the fact that the daughter's rollover IRA is an inherited one, with those benefits having been the participant who had the loan and from which inherited, prevent the inherited IRA holding the 50% interest in the participant loan promissory note?

Does the fact that wife #2's rollover IRA hold benefits that were once those of the very participant who signed the promissory note prevent the spouse's IRA from holding the 50% interest in that promissory note?

[Belgarath]

John - I'm sorry, but I'm just not getting the flow of your question.

"So we do not have identity between who is obligated on the note and who owns it as an asset."

But doesn't the plan own the outstanding loan as an asset? It isn't an "asset" that may be potentially assumed by another party - at least not in any plan I've ever seen. What I've seen is that the account balance is first automatically offset by the outstanding loan, and whatever is left is distributed to the named beneficiaries - in this case, the daughter and the wife#2.

If you somehow get past all this, or have a plan with different terms than I'm accustomed to, then I'm jut not sure of the answer. My gut says no, but without doing some research, I have no sound basis for my gut reaction.

How's that for a useless answer!

[Bird]

I agree (with Belgerath). I don't think a participant loan can be transferred to another party - estate, beneficiary, whatever. It should be extinguished at death. The loan documents will generally make this clear, but if not, that's still how I'd handle it.

I remember a discussion about that here "not too long ago" but that could be anywhere from 3 months so 3 years ago.

Sorry if that's not all that helpful.

[A Shot in the Dark]

Perhaps this a much more simplistic view of the situation.

In almost all Participant Loan Policies that I have seen, the outstanidng partiicpant loan becomes due and payable at the termination of employmnent of the Participant.

The death of the Participant would certainly cause the termination of employment.

Failing to repay the required loan payment (in this case the balance in full) would create a default, thus creating a taxable event.

The taxable event would zero the asset.

There is no asset to transfer.

[TPAMan]

Unfortunately for the daughter, it looks like the parents were spending her inheritance!

Would be a rare case for the daughter to cause the spouse/estate to repay the Plan for the outstanding loan.

[J Simmons]

I appreciate your comments. While not entirely helpful, not as useless as Belgarath suggested in his last sentence.

[Kevin C]

John,

Did you find something that says a participant loan can be rolled over into an IRA? I didn't think that was possible.

1.401(a)(31)-1, Q&A 16 says that a plan may allow rollover of a participant loan to qualified trust described in section 401(a) or a qualified annuity plan described in section 403(a). I don't see any mention of IRA's.

1.402©-2, Q&A 9 says a distribution of a loan offset can be an eligible rollover distribution. But, it is for a 60 day rollover of an amount equal to the loan offset, not a rollover of the loan.

[J Simmons]

Hi, Kevin C,

I agree that a participant loan cannot be rolled into an IRA owned by that participant.

My questions have a bit of twist. The deceased participant was the obligated borrower, and following his death, his estate is now obligated to repay the loan.

If before the estate is able to repay the loan, the death benefits are to be rolled out of the plan (part into an 'inherited IRA' owned by the daughter and the other part into an IRA of which the surviving spouse is the owner).

The surviving spouse is not obligated to repay the loan. The decedent's estate is the successor in interest to the participant, and now obligated to repay the loan. Since the IRA owner is not the obligated debtor on the loan, can the loan (or on my situation, part of them) be rolled into the IRA?

So too with the daughter's IRA, except that it is owned by the daughter "as beneficiary of" the deceased participant and it is an inherited IRA. So even if the surviving spouse's IRA is perhaps allowed to hold the loan (or part of it), the daughter's IRA might not. So that's my second question, whether the daughter's inherited IRA could hold any part of the loan?

[Bird]

The deceased participant was the obligated borrower, and following his death, his estate is now obligated to repay the loan.

I think the problem all of us are having with this thread is this concept. What makes this loan different from every other participant loan, that it doesn't simply become a taxable event at death? The fact that the estate is not the plan beneficiary is not relevant, IMO.

[Bird]

Obsessing a bit...

This is the thread I was thinking about; it's not conclusive but at least I am consistent.

The participant took the loan. He didn't pay it all back before he died. It just doesn't make sense that anyone other than the participant or his estate should get the taxable event.

[J Simmons]

Obsessing a bit...

This is the thread I was thinking about; it's not conclusive but at least I am consistent.

The participant took the loan. He didn't pay it all back before he died. It just doesn't make sense that anyone other than the participant or his estate should get the taxable event.

Bird, thanks for looking up the thread your were thinking of and linking it here in this thread--and your memory serves--it was in the 3 mo to 3 yr time frame!