Life and Death Planning for Retirement Benefits

112

Life and Death Planning for Retirement Benefits

and the repayment terms. § 72(p)(2) . For explanation of these requirements, see Chapter 14 of The Pension Answer Book ( Appendix C ). Benefits in certain plans may not be used as security for a plan loan to the employee unless the spouse consents. § 417(a)(4) ; see ¶ 3.4.02 . A plan loan is not treated as an income-taxable distribution at the time it is made if it meets the requirements of § 72(p)(2) ; if it does not meet those requirements, or if it initially meets those requirements but the participant later defaults, the result is a “deemed distribution.” See “A” and “B.” A plan loan can also generate an “offset distribution”; see “C.” These two types of distributions (deemed vs. offset) have very different tax consequences. A. Deemed distribution caused by “flunking” § 72(p) . If the loan does not meet the requirements of § 72(p) (either from the beginning, or because the employee later fails to meet the statutorily required repayment terms) the loan (or, if the problem is that the loan exceeded the permitted amount, the excess part of the loan) is treated as a deemed distribution to the employee. § 72(p)(1)(A) . If, after the loan was treated as a deemed distribution, the employee does in fact repay the loan, then such repayments to the plan are treated as after-tax contributions to the plan for purposes of computing the employee’s basis (investment in the contract). Reg. § 1.72(p)-1 , A-21; ¶ 2.2 . A deemed distribution under § 72(p) :

 Is not an eligible rollover distribution ( ¶ 2.6.02 ); Reg. § 1.402(c)-2 , A-4(d); § 1.72(p)-1 , A-12.

 Cannot be a tax-free “qualified distribution” if made from a DRAC ( ¶ 5.7.04 (C)); Reg. § 1.402A-1 , A-11.

 Does not count towards fulfilling the minimum distribution requirement ( ¶ 1.2.02 (B)); Reg. § 1.401(a)(9)-5 , A-9(b)(4).

 Is subject to the 10 percent early distributions penalty if the participant is under age 59½ and no exception applies; see ¶ 9.1.03 (D).

B. Deemed distribution caused by loan default. If the loan is initially compliant (see “A”), but then the participant defaults on the loan, the default causes a deemed distribution equal to the remaining loan balance. This deemed distribution occurs upon expiration of the plan’s “cure” period for the missed loan payment (which cannot be later than the end of the calendar quarter following the calendar quarter in which the missed loan payment was originally due). Reg. § 1.72(p)-1 , A-4 (fifth sentence), A-10(a), (b). Such a deemed distribution has the same tax effects as described at “A.” See Martinez , TC Memo 2016- 182 for an example of these rules in action. C. Plan loan offset distributions. If the loan complies with § 72(p) , we get away from the nonrollable deemed distribution that occurs when § 72(p) is violated. We then encounter another type of loan-related distribution, the “plan loan offset distribution” that occurs when the employee’s termination of employment (or death) causes the loan to be accelerated. Typically, the plan requires the loan to be repaid immediately in that event, deducts the loan balance from the employee’s account, and distributes to the employee (or