deceased participant questions

[Santo Gold]

An owner of a small 401k plan passed away. He was age 55.

Divorced from his spouse so he named his 2 children as beneficiary.

If both are under age 18, what distribution options are there? Can they legally make a decision in regard to this matter? Do they have the opportunity to have the account rolled over to an IRA?

If one is under 18 and the other over 18 (assumed that they are 50/50 beneficiaries) we can treat 1 beneficiary different from the other, correct?

To make things more interesting, the deceased participant had an outstanding loan in the plan, total still outstanding of $18,000. How does that factor into the mix?

Thanks for any comments.

[ETA Consulting LLC]

An owner of a small 401k plan passed away. He was age 55.

Divorced from his spouse so he named his 2 children as beneficiary.

If both are under age 18, what distribution options are there? Can they legally make a decision in regard to this matter? Do they have the opportunity to have the account rolled over to an IRA?

They can be rolled over into inherited IRAs, but not regular IRAs since neither is the surviving spouse. The individual who is less than 18 may have benefits paid to their legal guardian (but only with respect to their inability to make such decisions on their own). For instance, I'd treat a 16 year old and an 18 year old the same; but will treat a 6 year old differently.

If one is under 18 and the other over 18 (assumed that they are 50/50 beneficiaries) we can treat 1 beneficiary different from the other, correct?

Sure. In this Treasury Regulations were written around 2000 (or early 2000's) to provide each beneficiary treated as a separate account with a separate election. This pertained to situations where the spouse was one of the beneficiaries and enjoyed rights that other beneficiaries did not have (e.g. ability to roll over or enjoy a delayed Required Beginning Date for the death distributions).

To make things more interesting, the deceased participant had an outstanding loan in the plan, total still outstanding of $18,000. How does that factor into the mix?

Thanks for any comments.

The loan is a plan assets similiar to the other account balances. The taxability of the loan goes to the beneficiaries receiving the funds.

Good Luck!

[david rigby]

I'd treat a 16 year old and an 18 year old the same; but will treat a 6 year old differently.

Perhaps EtK is more knowledgeable in this area than I. Previously, I was told that a minor is a minor, without regard to age. Also told that a QP should (in general) pay a benefit due a minor by paying to the guardian of the estate FBO that minor, without regard to whether that person is guardian of the person.

Am I off-base?

[MoJo]

I'd treat a 16 year old and an 18 year old the same; but will treat a 6 year old differently.

Perhaps EtK is more knowledgeable in this area than I. Previously, I was told that a minor is a minor, without regard to age. Also told that a QP should (in general) pay a benefit due a minor by paying to the guardian of the estate FBO that minor, without regard to whether that person is guardian of the person.

Am I off-base?

I agree with you, David. If the person is a "minor" as defined by the state in which they reside, they are a minor for all purposes. The only exception would be the case of a minor who has been judicially "emancipated," in which case, they are considered capable of making "adult" decisions. One day under 18 is still a minor.... 18 or older - not a minor (but probably still too immature to make real decisions - IMHO). So, yes, the two can be treated differently if there ages are on opposite sides of 18.

I also agree with you that there is a distinction between a guardian of the estate (one who tends to the property of the person under guardianship) and a guardian of the person (one who has custody and is charged with the care of the minor) - but in many cases, one guardian serves both roles. If no "guardian of the estate" exists, then a court needs to appoint one before a decision/distribution can be made (however, in some states, there are exceptions to the "formal" guardianship process for "small" amounts - which varies from state to state).

Have counsel advise with respec to the pertinent facts and law in the jurisdiction you are in.

[Bird]

I'm surprised no one has said it already, but read the document. Mine says:

If a distribution is to be made to an individual who is either a minor or legally incompetent, the Plan Administrator may direct that such distribution be paid to the legal guardian. If a distribution is to be made to such person and there is no legal guardian, payment may be made to: (i) a parent, (ii) a person holding a power of attorney; (iii) a person authorized to act on behalf of such person under state law, or (iv) the custodian for such person under the Uniform Transfer to Minors Act, if such is permitted by the laws of the state in which such minor resides. Such payment shall fully discharge the Trustee, Plan Administrator, Trust Fund, and the Employer from further liability on account thereof.

And I'm quite sure the loan is taxed to the participant's estate; the beneficiaries are only taxed on what they get.

[Santo Gold]

Thanks to all for the replies. Just learned that the beneficiaries are NOT minors (one is age 27 and the other is 30). So, do they have the option to rollover their portion of the account balance or is it required that they take the distribution in cash?

Thanks

[mbozek]

I'm surprised no one has said it already, but read the document. Mine says:

If a distribution is to be made to an individual who is either a minor or legally incompetent, the Plan Administrator may direct that such distribution be paid to the legal guardian. If a distribution is to be made to such person and there is no legal guardian, payment may be made to: (i) a parent, (ii) a person holding a power of attorney; (iii) a person authorized to act on behalf of such person under state law, or (iv) the custodian for such person under the Uniform Transfer to Minors Act, if such is permitted by the laws of the state in which such minor resides. Such payment shall fully discharge the Trustee, Plan Administrator, Trust Fund, and the Employer from further liability on account thereof.

And I'm quite sure the loan is taxed to the participant's estate; the beneficiaries are only taxed on what they get.

Outstanding loan balance is taxed to the deceased's participants estate b/c he had legal obligation to pay off the plan loan. Beneficaries can only be taxed on the benefits they receive from the plan.

[masteff]

So, do they have the option to rollover their portion of the account balance or is it required that they take the distribution in cash?

Yes, they can do a direct rollover but double check your plan. Refer to IRS Notice 2007-7.

[ETA Consulting LLC]

Outstanding loan balance is taxed to the deceased's participants estate b/c he had legal obligation to pay off the plan loan. Beneficaries can only be taxed on the benefits they receive from the plan.

I would like to see a cite for this. The loan is still a plan asset that is inherited by the designated beneficiary in the same manner as other assets in the plan. The designated beneficiary would have the option of disclaiming the "entire" account.

Do we have a cite for this?

[SheilaD]

I don't have a cite handy - but I will say that we always treat the loan on death as taxable to the participant's estate. The beneficiaries are no part of the loan agreement between the plan and the participant. I can't see how you can tax them on a debt they did not create. I'm interested to hear what others say.

[masteff]

Loan offset can occur when the participant has a distributable event. Death is generally speaking a distributable event. Practically speaking, I am not aware of any plan that distributes loans to beneficiaries.

Even if you can have the loan survive the death, why would you want to? It's a burden that should not be placed upon a beneficiary.

And the classic answer also applies: what does the plan say?

[K2retire]

I've seen only one instance where a beneficiary wanted to inherit the loan. It was a married couple who owned the business that sponsored the plan. Since the widow was filing a joint return, she would have been taxed on the deemed loan and chose to continue making the payments.

[MoJo]

Loan offset can occur when the participant has a distributable event. Death is generally speaking a distributable event. Practically speaking, I am not aware of any plan that distributes loans to beneficiaries.

Even if you can have the loan survive the death, why would you want to? It's a burden that should not be placed upon a beneficiary.

And the classic answer also applies: what does the plan say?

If the bene's are flush with cash (say, from an insurance policy on the life of the deceased), by paying off the loan, they effectively increase the value of the distribution from the plan that is then rolloverable into a tax sheltered vehicle (inherited IRA) obtaining the benefits of perhaps years of tax deferred growth. Money moving from one taxable pocket to a tax deferred pocket. If it were me, I'd certainly run the numbers....

The issue though is one of timing. There is a rather short window before hte loan will be defaulted, and it would to be paid off before that occured.

[mbozek]

The following quote is take from assigning and loaning plan benefit funds by Paul Hamburger, Thompson Publishing group, P 101

"Death of the Participant

Another common default event is the participant's death. Plan administrators are often unsure how to deal with plan loans that are outstanding on the participant's death. One relateively simple approach is to reduce the participant's benefit on death by the amount outstanding on the loan. The beneficiary then receives the balance of the participant's benefit. This approach appears to be contemplated by IRS regulations [citing Reg. 1.401(a)-20 Q/A 24(d) which provides that the accrued benefit payable to a spouse under the QPSA and QJSA shall be reduced by the security interest outstanding on a loan to the participant at the time of death or payment, if the security interest is treated as payment in satisfaction of the loan under the plan. A plan may offset the participant's loan outstanding at the participant's death which is secured by the participant's interest in the account balance against the spousal benefit required to be paid under IRC 401(a)(11)(b)(iii)]. The tax consequences of this approach appear to be that the participant's estate is taxed on the amount outstanding on the date of death and the beneficiary is taxed on the remaining portion of the account."

Other sources cited are PLR 8103063 and Shull v. Stone Machinery Co. PS Plan, 836 Fed 2d 306.

It appears that there is no IRS policy on taxation of plan loans at death other than that some party, e.g., estate of participant, beneficiary, etc must be taxed on the amount of imputed income on the outstanding loan balance. It is up to the plan administrator to decide who will be taxed.

[david rigby]

It is up to the plan administrator to decide who will be taxed.

... by making sure the plan is specific?

Presumably you are not implying PA discretion.

[mbozek]

Why not discretion? Whiile plans provide for distribution upon specified events, plans dont define who is the party who will be taxed in every event. For example plans provide that MRDs must be made after death of the participant but do not specify who must recieve the payment (can be estate or beneficiary). I dont think many plans have specific language designating who will be taxed in the event that a participant dies with an outstanding loan. As noted above in one case the beneficiary has asked that the loan be included in the distribution amount.

[ETA Consulting LLC]

A plan may offset the participant's loan outstanding at the participant's death which is secured by the participant's interest in the account balance against the spousal benefit required to be paid under IRC 401(a)(11)(b)(iii)]. The tax consequences of this approach appear to be that the participant's estate is taxed on the amount outstanding on the date of death and the beneficiary is taxed on the remaining portion of the account."

I understand the argument, but don't necessarily agree with that. A loan offset is, by definition, a taxable distribution. It still boils down to who is the taxable distribution to. It appears to be just as consistent in saying the taxable distribution is to whomever's balance is being offset. So, when the beneficiary inherits the account, the offset will become a taxable distribution to her (or he/she can actually roll it over either to an inherited IRA or traditional IRA if the spouse). They can, however, disclaim the entire account (presumably to the participant's estate), but I just don't see where you could cherry pick different assets to different beneficiaries.

I do see the argument, though, and am much appreciative. I would've never found it

Good Luck!

[mbozek]

A plan may offset the participant's loan outstanding at the participant's death which is secured by the participant's interest in the account balance against the spousal benefit required to be paid under IRC 401(a)(11)(b)(iii)]. The tax consequences of this approach appear to be that the participant's estate is taxed on the amount outstanding on the date of death and the beneficiary is taxed on the remaining portion of the account."

I understand the argument, but don't necessarily agree with that. A loan offset is, by definition, a taxable distribution. It still boils down to who is the taxable distribution to. It appears to be just as consistent in saying the taxable distribution is to whomever's balance is being offset. So, when the beneficiary inherits the account, the offset will become a taxable distribution to her (or he/she can actually roll it over either to an inherited IRA or traditional IRA if the spouse). They can, however, disclaim the entire account (presumably to the participant's estate), but I just don't see where you could cherry pick different assets to different beneficiaries.

I do see the argument, though, and am much appreciative. I would've never found it

Good Luck!

If the IRS wants to impose a uniform rule that the imputed value of the outstanding loan balance is to be taxed to the beneficiary of the retirement benefit they can do so. It is to be noted the the 72p regs do not define who is taxed on a loan default due to death of a participant. Until the IRS clarifies the rules the plan can elect to declare the imputed value of the loan taxable income to the estate of the deceased taxpayer.

While partial disclaimers of property transfers are permitted under IRC 2518 I dont know why a plan would require a beneficiary to excute one since the IRS doesnt care who is taxed on the imputed value of the outstanding loan. The reg cited above is substantial authority that the beneficiary is only taxed on the participant's accrued benefit after the outstanding loan amount is subtracted.

[Anonymoose]

Our document provides that the unpaid loan balance will be taxable to the decedent. Should the 20% federal income tax on the loan balance be withheld from the beneficary's distribution?