How to do RMD Account Value Calculation when Account Includes Participant Loan?

[The 402"(G)"]

Hello,

I have a semi-rare situation for an HCE's RMD calculation.

The account value at 12/31 was $1000, but there was an outstanding loan of $45,000 at the time. (Took the loan, then distributed whole account - still employed).

Would we calculate the RMD with a $1000 balance or a $46,000 balance? From the research done, I found a few answers to say include the loan, a few answer to not include the loan. Surprisingly, basically no information on the matter across the board. The IRS & various Publications are silent on the matter - no mention of loans.

We are torn 50/50 on the matter - has anyone had experience with this before? We are looking to find some type of backup or codification on the matter that would make this clear for us

Thank you in advance,

[MoJo]

From my perspective, the loan is nothing more than an investment held in the participant's account, and hence, the "value" of the participant's account is $46,000.  I'm not sure of any exemption from the RMD requirements for excluding the loan from the calculation.

 

Now, distributing a "part" of the loan may be problematic.....

[The 402"(G)"]

Would you happen to know where I could find some type of IRS backup for what is specifically included and excluded? The logic is there, but I guess my concern to me is this seems like something that would be specifically stated somewhere when discussing the calculation. It seems odd to me that everything I researched is completely silent on the issue.

 

Distributing won't be an issue, enough will be paid back and contributed by the time it needs to be paid.

[MoJo]

I can't say for sure if there is any "authority" specifically on point, but the analysis is simply that while "cash" left the account, it was replaced with an (enforceable) promissory note of equal value.  Hence, the balance doesn't actually go down as a result of the loan having been issued.  I can comprehend of no other result with respect to the balance of the account.

[Belgarath]

1.401(a)(9)-5 discusses the requirements for a DC plan. Basically, since the "account" is not reduced for an outstanding loan, then the value of the loan is included by default.

Since you clearly cannot distribute funds that are not actually in the plan, if you DID have a calculated RMD in excess of the assets, you'd probably have to rely on plain old common sense, and perhaps the sentence in Q&A-1 that says, "However, the required minimum distribution will never exceed the entire account balance of the date of distribution." An imperfect justification at best, but I don't see any other option than to handle, for these purposes, as if there is some "non-vested" money, even though there isn't. See A-8 for a discussion of that methodology.

I have a hard time imagining that an IRS auditor would attempt to assert a RMD failure in such a circumstance.

[RatherBeGolfing]

A few thoughts for this discussion..

If an account has both vested and unvested balances at the time the AB is calculated for RMD purposes, the RMD would be calculated on the total balance but only paid from the vested balance.  If there is not enough in the vested portion to pay the full RMD, the remainder is "rolled" to the following years distribution.  Could you apply the same principles here?  Calculate the RMD using a balance of $46,000, if the RMD exceeds the $1,000 available funds, add the remainder to the next years RMD which will have more cash available after a year of loan payments.

 

[BG5150]

^ That was my first thought.

[Lou S.]

Could you issue a 1099-R for a partial loan offset and reduce the outstanding balance of the loan by the portion that is considered an RMD?

Alternatively you could probably just wait until the participant makes a few loan payments this year and they will more than likely have enough cash in the account to cover the RMD.

[BG5150]

Lou, I thought about that, but you still have payments that need to be made.  How do they get treated?  Do they create basis now?

[Lou S.]

3 hours ago, BG5150 said:

Lou, I thought about that, but you still have payments that need to be made.  How do they get treated?  Do they create basis now?

Good question I'm not sure I know the answer.

I'd be tempted to treat the RMD as a phantom "loan payment" that directly reduced the principal. But I'm honestly not sure there is any authority for that approach even if it makes logical sense.

 

[RatherBeGolfing]

40 minutes ago, Lou S. said:

Good question I'm not sure I know the answer.

I'd be tempted to treat the RMD as a phantom "loan payment" that directly reduced the principal. But I'm honestly not sure there is any authority for that approach even if it makes logical sense.

 

I think that is a fair approach as long as loan docs allow for payments outside of the amortization schedule.

[The 402"(G)"]

Thank you everyone for the replies. The more I've thought about this, it does seem right to include the loan. As mentioned, the logic to not include just isn't there.

Thankfully in our case the side issue of not having the funds does not have to be addressed. But I will chime in with my 2 cents that since there is no definitive answer on what would happen, I think the vesting rule would be a logical approach to it. Take whatever couldn't be taken out and add it to next years calculated distribution.

I will let anyone know if I find anything else! Maybe it's something so obvious I am overthinking it, but I am surprised there is not a more clear answer from the Regs. It doesn't seem like something that would be too rare of an occurrence.

[Belgarath]

FWIW, I'd say it would be extremely rare. Certainly I've never seen, nor even heard of such a situation, until now. Perhaps others have seen it with some frequency - I don't know.

[Bird]

Coming in late here but FWIW, there is no doubt in my mind that the loan IS counted for purposes of determining the RMD, and the vesting rule does NOT apply (that is, you don't get out of the RMD simply because cash isn't available).  I don't see not having a vested account and not having cash as being analogous.

[Lou S.]

To amplify Bird's prior response which I think it is totally on point.

The participant loan issue is much more analogous to having too much tied up in an illiquid asset which does not relieve you from the RMD requirement.

 

[Mike Preston]

What is the age of this person?  I just don't understand how 4 quarterly payments won't generate enough cash to satisfy the RMD.  Can somebody explain why so much effort is being expended in this thread without getting real numbers?

[MoJo]

19 minutes ago, Mike Preston said:

What is the age of this person?  I just don't understand how 4 quarterly payments won't generate enough cash to satisfy the RMD.  Can somebody explain why so much effort is being expended in this thread without getting real numbers?

I'm not sure the numbers change the analysis.  The thread is about an "illiquid" investment and RMDs.  Consider an account that has $20,000 in marketable securities plus $20,000 in a promissory note for a total account balance of $40,000 - on 12/31/anyyear.  Now consider on the first business day of the following year, the marketable securities drop significantly in value (below the RMD amount), not to recover throughout the year.  I don't care how much the payments may contribute to the equation if they don't contribute enough to process the RMD based on the $40,000 account value.

Think it won't happen?  Go back and check out what happened in the early parts of the Great Recession.  I know personally of some RMD issues as a result of this.  I also know Congress suspended RMDs for a year because the RMD amount was a substantial portion of their remaining account balances - as a result of the market crash(es).

Besides, the OP already said the payments were sufficient to cover the RMD - he was asking a hypothetical.

[Mike Preston]

But, but, but....... this thread has long since left the comfortable confines of the original: "Do you include the value of the loan?" discussion because (I hope) everybody agrees that since there is absolutely no exclusion it is obvious that it IS included.  Hence, it is perfectly reasonable to expand the discussion to cover a different fact pattern, such as:

"I don't care how much the payments may contribute to the equation if they don't contribute enough to process the RMD based on the $40,000 account value."

My point is that it isn't like this situation is "semi-rare".  This issue is extraordinarily rare.  Even the case you describe: "Consider an account that has $20,000 in marketable securities plus $20,000 in a promissory note ...." has to also see the promissory note payments be extraordinarily low or the age of the participant be extraordinarily high before the cash generated won't be enough to satisfy the RMD's.

When you are dealing with extraordinarily rare circumstances, the actual numbers are extremely significant because a close analysis of those numbers might give rise to a solution that would not necessarily present itself  otherwise.

[MoJo]

1 hour ago, Mike Preston said:

My point is that it isn't like this situation is "semi-rare".  This issue is extraordinarily rare.  Even the case you describe: "Consider an account that has $20,000 in marketable securities plus $20,000 in a promissory note ...." has to also see the promissory note payments be extraordinarily low or the age of the participant be extraordinarily high before the cash generated won't be enough to satisfy the RMD's.

When you are dealing with extraordinarily rare circumstances, the actual numbers are extremely significant because a close analysis of those numbers might give rise to a solution that would not necessarily present itself  otherwise.

You now have to define "extraordinarily rare" because I see it several times a year.  Usually, it's a lack of planning on the part of the participant who has an SDBA that invests in things that may be illiquid (limited partnerships being a favorite, real estate crops up often) and the "law firm" they work for doesn't actually place any restrictions on what can be held in the plan....

Beside, rare or not, it stretches the mind to have these discussions.  Mental atrophy does, in fact, set in in our dynamic profession....

[Mike Preston]

Amen to that! (Mental atrophy)

I have a number of TPA clients that (theoretically) run things like this by me and this low level of liquidity vs. RMD's has literally never come up. Now, if you are talking a SDBA by a partner in a law firm that has generated this problem, how about the following for a solution:

Partner buys all or a portion of a not liquid asset from the plan. Files via voluntary compliance with the DOL to "correct" the prohibited transaction. Pays the 5330 excise tax. Partner bears all extraordinary costs.

BTW, I still don't think your example makes much sense because can't the promissory note be distributed, in full if necessary, and the participant can come up with cash to roll over to an IRA within 60 days all that is rollable?

[RatherBeGolfing]

16 hours ago, Mike Preston said:

Partner buys all or a portion of a not liquid asset from the plan. Files via voluntary compliance with the DOL to "correct" the prohibited transaction. Pays the 5330 excise tax. Partner bears all extraordinary costs.

Or just don't let them invest in stuff that will become an issue 

[Mike Preston]

Sure.  But we are mind-stretching an after-the-fact solution!

[MoJo]

On 3/31/2017 at 6:16 PM, Mike Preston said:

Amen to that! (Mental atrophy)

I have a number of TPA clients that (theoretically) run things like this by me and this low level of liquidity vs. RMD's has literally never come up. Now, if you are talking a SDBA by a partner in a law firm that has generated this problem, how about the following for a solution:

Partner buys all or a portion of a not liquid asset from the plan. Files via voluntary compliance with the DOL to "correct" the prohibited transaction. Pays the 5330 excise tax. Partner bears all extraordinary costs.

BTW, I still don't think your example makes much sense because can't the promissory note be distributed, in full if necessary, and the participant can come up with cash to roll over to an IRA within 60 days all that is rollable?

"Partner buys all or a portion of a not liquid asset from the plan. Files via voluntary compliance with the DOL to "correct" the prohibited transaction. Pays the 5330 excise tax. Partner bears all extraordinary costs."

Not a practical solution.  Amazing how asset rich and cash poor many high earners are.

"BTW, I still don't think your example makes much sense because can't the promissory note be distributed, in full if necessary, and the participant can come up with cash to roll over to an IRA within 60 days all that is rollable?"

Not a practical solution.  Amazing how asset rich and cash poor many high earners are.

We have an entire book of business that we bought that contain a large number of such law firms - and some of the largest in the country.  The only practical solution is to not allow such investments in the plan - but the practicality of it is a decision for the client - not us.

We actually bid on, and then withdrew from ("there is a "God!") the hunt on a law firm that had 300 employees and over 1200 limited partnership interests in the plan - including limited partnership interests owning the building the law firm occupies - and they have a large and very well respected ERISA practice....

[BenefitJack]

Sorry about the length of this response.  Outstanding loan principal is certainly part of plan assets.     

I would amend the plan and the provisions regarding loans, to explicitly authorize the plan administrator to limit/adjust loans where necessary to otherwise comply with the code/regulations.  Many plans have such provisions regarding deferrals - to meet non-discrimination testing without triggering distributions.  

Similarly, the plan sponsor may want to curtail in-service distributions/withdrawals while a loan is outstanding.    

Note that the rule for RMD's for a 401(k) is not the same as for an IRA - in an IRA, you calculate the RMD separately for each IRA, but you can aggregate the total and take the entire distribution from a single IRA.  In the 401(k) space, you must calculate and satisfy your RMDs separately for each plan and withdraw that amount from that plan.  So, there is no opportunity for the taxpayer to aggregate her 401(k) plans to satisfy RMD.  The exception to that rule is in 403(b) tax-sheltered annuities, where you can calculate the RMDs for each plan and then take the total from any one (or more) of the tax-sheltered annuities.

Assuming the plan accepts IRA rollovers, and assuming the plan permits loan repayment acceleration (I would amend the plan accordingly if it did not so permit), the plan administrator would reach out to the participant and ask her to provide the appropriate amount (either in the form of an accelerated loan repayment or in the form of an IRA rollover), which the plan administrator will then turn right around and payout to meet RMD requirements.  Assuming the individual just turned age 70 1/2 and the 1st RMD was due to be paid by April 1st 2017, I think you have a problem.  The only saving issue here is that if it was the first RMD payable by April 1, 2017, we are talking about ~$1,679, where the $1,000 cash equivalent investment is just slightly short, and the 50% penalty would be ~$340.  

However, if the next RMD is not due until December, I agree with the prior commentary that loan payments (no less frequently than quarterly, level amortization) should be adequate to meet RMD requirements for 2017.  A $45,000 loan principal @ ~5%, repayments to be amortized over 20 quarters (5 years), means a quarterly repayment of $2,500+ ($10,000+ a year).    

Assuming the plan document provides the plan administrator the authority to adjust existing loans, I would add a plan provision that all loans are subject to recharacterization into a distribution and a new, lower amount of outstanding loan principal to the extent necessary to comply with RMD requirements (or any other code/regulatory requirement).  No cash is distributed, the recharacterization results in reporting a taxable payout (similar to a loan default at separation).  

That said, I think it would be rare to see a situation where an individual had a vested account balance of say $100,000+, who took a loan of $50,000, then soon thereafter, ended up with an account balance of only $46,000, where only $1,000 is in cash equivalent investments and $45,000 is the outstanding loan amount.  Perhaps you can get there if the plan allows withdrawals while a loan is outstanding, but, if it does, why wouldn't those withdrawals qualify to meet the requirements for RMD?    

[K2]

33 minutes ago, BenefitJack said:

.  Perhaps you can get there if the plan allows withdrawals while a loan is outstanding, but, if it does, why wouldn't those withdrawals qualify to meet the requirements for RMD?    

 

Perhaps they were rolled over