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 Under certain conditions, it is possible to obtain a loan from your 403b plan. But you've got to work closely with your plan administrator to make sure that the loan isn't viewed as an early distribution. If a loan is viewed as a distribution, it'll be reported as income, and if you're under age 59 1/2, then you may be subject to a 10% tax penalty.
403b Loan Limitations
If your 403b annuity plan offers this benefit, it is possible to obtain a loan from your 403b account before age 59 1/2 without incurring a penalty. However, if the provisions of the 403b loan are not adhered to, then the loan may be deemed a distribution. And if your not age 59 1/2, then additional tax penalties may apply.
The following list summarizes the 403b loan rules that you need to follow to stay clear of the early distribution penalties:
- First off, your 403b plan, or the tax-sheltered annuity, must provide for loans. That means your plan must be set up to allow for loans.
- The limit on all loans, at any time, cannot exceed $50,000. This means all loans from this employer cannot exceed $50,000.
- Payments on the loan must be made quarterly (at a minimum). The loan agreement may provide for a three-month grace period, and may also allow a participant to suspend payments during military service.
- The term of the 403b loan may not exceed 5 years, unless the money is used for the purchase of a principal residence.
- Finally, the loan must bear a reasonable rate of interest.
If you fail to pay an amount due on a loan, or default on the loan, then the IRS will treat the entire distribution (not just the remaining balance) as a distribution. In that situation, the 10% early withdrawal penalty will apply.
403b Hardship Distributions
It is possible to obtain a hardship distribution from your 403b plan. Please note, that this is not considered a hardship loan; rather it is considered a distribution. Hardships must be demonstrated, and result in an "immediate and heavy" financial burden. Failure to meet these criteria can jeopardize the status of the tax sheltered annuity.
Hardship Distribution Rules
In order to take a 403b hardship distribution, you're probably going to have to prove that you're under severe financial distress and have no other viable resources available to you to deal with that burden. Examples of allowable hardships include:
- Medical Expenses - payment on any un-reimbursed medical expenses of the plan participant, their spouse, and dependents.
- Primary Residence - money used as a down payment on a primary residence.
- College Expenses - includes tuition and fees associated with post-secondary education expenses for the next 12 months.
- Foreclosure - money needed to prevent eviction or foreclosure on your primary residence.
The above types of hardship withdrawals are allowed by an IRS provision that asks employers to provide for a safe harbor withdrawal if there exits an immediate and heavy financial need or burden
Taking a 403b Hardship Withdrawals
Please note that hardship withdrawals are not necessarily exempt from an additional 10% tax penalty. In addition, withdrawals of this type are subject to federal income tax as they are viewed as ordinary income.
You may also be asked to certify that you have no other way of accommodating this burden - including the possibility of taking a loan (including a 403b loan). You will also be likely prohibited from contributing to your 403b plan for six months.
Finally, it's not possible to perform a 403b rollover into another retirement plan or IRA with a hardship distribution.
Borrowing from a 403b
Before making any decision to borrow from your 403b - whether it is a loan or hardship distribution - you need to make sure that you've exhausted all other alternatives including taking out a personal loan. Remember, you're borrowing against your future to pay for expenses today and that's not a good thing.
For example, if you take a 403b loan, then you're going to be prohibited from participating in your plan until all of the money is repaid. If your employer matches your contributions, then you're missing out on that benefit. And if you eventually decide you cannot repay the loan then you're going to owe income tax and pay a 10% early withdrawal penalty.
In addition, if you decide to leave your employer before the loan is repaid, then you may be required to immediately repay the entire loan or be faced with tax penalties. What we're trying to demonstrate is that taking a 403b loan should not be an easy decision. In fact, it's probably a good idea to consult with a tax professional or lender before taking money out of your 403b.
If you'd like to run through some scenarios using alternative sources of money, to see what your monthly payments might look like, then take a look at our personal loan calculators.
403b Sponsor Rules
Your plan sponsor also has certain responsibilities with respect to 403b loans. Failure to identify and report loans that do not comply with the above rules may be deemed as a taxable distribution that should be reported to the employee as income.
For example, if an employee has more than $50,000 in outstanding loans with the employer, or fails to make timely payments on a 403b loan, then the plan's sponsor must report the loan as a taxable distribution to the employee.
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