Advanced Underwriting Consultants

Ask the Experts – August 22

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

 Question:  My client is leaving the employ of her 401K plan sponsor.  The client has a $40,000 outstanding loan against the 401K.  If she lets the loan lapse, and then contributes $40,000 to an IRA within 60 days, would that be a proper rollover?

Answer:  Yes, it seems so.

A plan loan is deemed a taxable distribution when the loan repayment is in default.  Default is determined based on the plan language.

The regulations say that a deemed distribution due to a loan default is an eligible rollover distribution.  Thus, the participant can replace the loan amount with outside funds inside a rollover IRA within 60 days of the date of default.  Here’s the excerpt from Treasury Regulation 1.402(c):

Q-9: What is a distribution of a plan loan offset amount, and is it an eligible rollover distribution?

 A-9: (a) General rule. A distribution of a plan loan offset amount, as defined in paragraph (b) of this Q&A, is an eligible rollover distribution if it satisfies Q&A-3 of this section. Thus, an amount equal to the plan loan offset amount can be rolled over by the employee (or spousal distributee) to an eligible retirement plan within the 60-day period under section 402(c)(3), unless the plan loan offset amount fails to be an eligible rollover distribution for another reason. See § 1.401(a)(31)-1, Q&A-16 for guidance concerning the offering of a direct rollover of a plan loan offset amount. See § 31.3405(c)-1, Q&A-11 of this chapter for guidance concerning special withholding rules with respect to plan loan offset amounts.

And here’s a link to a 2012 private letter ruling where the idea is discussed in more detail.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.