403(b) w/outstanding loan at death and repayment of loan by beneficiary | Ed Slott and Company, LLC

403(b) w/outstanding loan at death and repayment of loan by beneficiary

$55,000 403b with $18,000 outstanding loan at death. Beneficiary wants to repay loan with life insurance proceeds and then rollover the 403b to an inherited IRA.

Problem I see is that she is repaying the loan with tax free money and the amount of the loan repayment within the 403b becomes taxable when the money is taken out later, even though it was repaid with tax-free life insurance proceeds. I'm not sure this part is even correct.

Seems it may be better and simpler to not repay it. I think the estate would receive a 1099 for the outstanding loan. Deceased was under 59 1/2 at death but 10% penalty would be waived because of death, I think.

Thoughts?

Yes, the consensus seems to be that the estate would otherwise receive a 1099R for offsetting the loan, and the beneficiary receives the reduced plan balance. However, it depends on whether the estate is solvent or not, and if solvent whether the beneficiary of the 403b is also the beneficiary of the estate or if the estate beneficiary is someone else.

  • Apparently the beneficiary of the 403(b) is an individual, not the estate of the deceased, otherwise no rollover to an inherited IRA is permissible.  I would expect that an offset distribution satisfying the loan would be taxable to the individual beneficiary, not to the estate, and that the beneficiary would receive the code 4M Form 1099-R.
  • Even if it's permissible for the beneficiary to repay the loan to avoid an offset distribution, I'm not sure it makes much sense to do so unless, perhaps, the intent is to taxably roll the money over directly from the 403(b) to an inherited Roth IRA to be able to have subsequent growth be tax-free.  Otherwise it seems more sensible to not repay the loan and instead put that money into investments where subsequent growth is taxable at long-term capital gains rates instead of having it end up in an inherited traditional IRA in which subsequent growth will eventually be taxed at rates for ordinary income.
 

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