Expert: Allen - 9/23/2007

Question
I am the executor of my late psychiatrist, father-in-law's estate. He made the mistake of loaning in 1994 the entire amount of his pension plan, both a money purchase and profit sharing plans (about $330,000), to one of his ex-patients as an investment in one of that patient's lawsuits. I should state that this is a single participant plan. The original notes were termed for one year at 15% then renewed for another year at the same rate. They were secured by a deed of trust on a commercial property worth approximately the same amount as the principal loaned. No interest payments were ever made back to the pension trust fund. The original lawsuit proved fruitless and the notes expired unpaid and there stood a verbal agreement by the parties that the money would eventually be paid back. Another lawsuit was begun by the friend in 1998 and in 2001 my father-in-law loaned more money to his "friend" (about $100,000, though not from the pension plan) to help finance the legal expenses of the new case. A new contract was drawn up at that time giving my father-in-law a 25% interest in the award from the case. The idea was that all the money previously loaned from the pension plan would be paid back to the plan trust once the 25% share of the award came through. This case was settled in January of 2006 (the friend probably received around 1 or 2 million net) and the friend doesn't intend on paying the trust funds (or any other funds) back. Also, the friend sold the real estate which secured the original note from under my in-laws. It wasn't possible for me to file a lien against the case because my father-in-law gave expert witness testimony to help his friend. The upshot of all this is that my mother-in-law is left holding the bag. My question is: What kind of penalties or tax liabilities might we expect if we terminate the plan? Indeed, would my mother-in-law's personal assets be at risk? If so, why? Isn't the pension plan part of the corporate entity? No one else besides my in-laws suffered because of the bad investment.
Thank You.
M. Buckner

Answer
To answer your basic questions, while it is highly unlikely, if the IRS audited the plans it could say that the trustee did not invest the assets of the plans in a prudent manner. If your father in law was the only trustee, there is little it could do. If your mother in law was also a trustee, it could say she did a bad job. Your father in law's estate is the party that bore the burden of the bad investment. However, the IRS could say that the trustee is liable. Your father in law received a tax benefit when he made the contributions and because the trustee invested poorly no taxes are being paid when the trust is dissolved and the assets are distributed. While the plan was maintained by your father's business, once the money leaves the business, it's the trustee's responsibility to invest prudently.

Saying all this I want to reiterate in my opinion the likelihood of any problem is very very minor. However, you may want to contact an attorney in your area who is knowledgeable about pension and ERISA matters for clarification.

You may also want to hire an attorney to go after the friend (?) who your father in law lent the money to. There was a note and the borrower violated the terms of the note. I don't know if the fact your father in law gave testimony matters.

Good luck.