RMD and Defaulted Loan

[Rob P]

Hopefully and easy one, but I have never heard of this. We have a non-owner active participant who is age 74 with an outstanding loan balance in a 401(k) plan. The participant is terminating and wants to rollover their account to an IRA. They are aware that their 2013 RMD must be processed from their account prior to the rollover.

Question: Can we offset the actual RMD amount by the loan that will default?

It seems logically that you could since the tax consequences net to the same place, but we all know that logic doesn’t always rule.

Example: 2013 RMD is $6000 and participant has a $5000 loan balance that will default upon their termination in 2013. As such, I would give them a $1000 distribution and 1099 them for the entire $6000 with a tax code 7. Then allow her to rollover the remaining account to an IRA.

Thanks.

[Belgarath]

Just be careful that it is in fact an offset and not a "deemed distribution." A simple "deemed distribution" doesn't satisfy the RMD requirement.

Q-9. Which amounts distributed from an individual account are taken into account in determining whether section 401(a)(9) is satisfied and which amounts are not taken into account in determining whether section 401(a)(9) is satisfied?

A-9. (a) General rule. Except as provided in paragraph (b), all amounts distributed from an individual account are distributions that are taken into account in determining whether section 401(a)(9) is satisfied, regardless of whether the amount is includible in income. Thus, for example, amounts that are excluded from income as recovery of investment in the contract under section 72 are taken into account for purposes of determining whether section 401(a)(9) is satisfied for a distribution calendar year. Similarly, amounts excluded from income as net unrealized appreciation on employer securities also are amounts distributed for purposes of determining if section 401(a)(9) is satisfied.

(b) Exceptions. The following amounts are not taken into account in determining whether the required minimum amount has been distributed for a calendar year:

(1) Elective deferrals (as defined in section 402(g)(3)) and employee contributions that, pursuant to rules prescribed by the Commissioner in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter), are returned to the employee (together with the income allocable thereto) in order to comply with the section 415 limitations.

(2) Corrective distributions of excess deferrals as described in § 1.402(g)-1(e)(3), together with the income allocable to these distributions.

(3) Corrective distributions of excess contributions under a qualified cash or deferred arrangement under section 401(k)(8) and excess aggregate contributions under section 401(m)(6), together with the income allocable to these distributions.

(4) Loans that are treated as deemed distributions pursuant to section 72(p).

(5) Dividends described in section 404(k) that are paid on employer securities. (Amounts paid to the plan that, pursuant to section 404(k)(2)(A)(iii)(II), are included in the account balance and subsequently distributed from the account lose their character as dividends.)

(6) The costs of life insurance coverage (P.S. 58 costs).

(7) Similar items designated by the Commissioner in revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See § 601.601(d)(2)(ii)(b) of this chapter.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 33293, June 15, 2004; T.D. 9319, 72 FR 16894, Apr. 5, 2007]

[Rob P]

This is great stuff and exactly what I was looking for.

It is definitely an offset distribution since the participant is actually retiring and leaving the firm. The deemed distribution caveat is interesting because I would have thought it does not matter since the IRS is picking up the taxes anyway.

Thanks!!

[masteff]

Why not give the participant the $6,000 MRD, then they give you a check for $5000 to pay off the loan, afterwhich they rollover the balance? Same net effect and it avoids cutting corners.

[Rob P]

Good point. It's very nice elderly participant. I am looking for the least complicated approach for them.

[ETA Consulting LLC]

There are withholding rules that apply when cash is received the distribution. I would, first, let the loan offset serve to satisfy the RMD.

Good Luck!

[K2retire]

RMDs are not eligible for rollover, so no 20% withholding requirement.

[Rob P]

Thanks everyone for the comments, they are truly appreciated.

Just as a follow-up on withholding. I agree that RMDs are not subject to the 20% withholding, but it is my understanding that distributions not eligible for rollover are subject to 10% withholding, unless the participant specifies not to withhold in writing. We usually give our participant’s a W4-P for good measure.

[ETA Consulting LLC]

I was speaking to the RMD plus the loan offset being "taxable". In such instance, it would behoove the participant to allow the loan offset alone to satisfy the RMD. 20% withholding applies to the offset when cash is received from the distribution.

Good Luck!

[jpod]

74 is NOT elderly.

[Rob P]

Sorry, no insult intended.

I guess it’s true when they say you’re as old as you feel. And after doing 8 hours of yard work yesterday, I feel elderly myself.