Under certain conditions, it's possible to obtain a loan from a 403b plan. But it's important to work closely with the plan administrator to make sure the loan isn't viewed as an early distribution. If that occurs, then the distribution will be reported as income, and if the accountholder is under age 59 1/2, then a 10% tax penalty may apply.
403b Loan Limitations
If an employer's 403b annuity plan offers this benefit, it is possible to obtain a loan from an account before age 59 1/2 without incurring a penalty. However, if the provisions of the loan are not adhered to, then the loan may be deemed a distribution. Additional tax penalties may apply if the accountholder is not age 59 1/2 or older.
The following bulleted list summarizes the 403b loan rules that need to be followed to stay clear of the early distribution penalties:
If an individual fails to pay the amount due, or defaults on a loan, then the IRS will treat the entire loan (not just the remaining balance) as a distribution. In that situation, the 10% early withdrawal penalty will apply.
It is possible to obtain a hardship distribution from a 403b plan. Please note, 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, the accountholder will have to prove that they're under severe financial distress, and have no other viable resources available to deal with that burden. Examples of allowable hardships include:
The above list of hardship withdrawals are allowed by an IRS provision that asks employers to provide for a safe harbor withdrawal only in cases where there is an immediate and heavy financial need or burden.
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.
Plan participants may also be asked to certify they have no other way of accommodating this burden, including the possibility of taking a loan (including a 403b loan). Participants will likely be prohibited from contributing to their 403b plan for six months.
Borrowing Money from a 403b
Before making any decision to borrow from a 403b account, whether it is a loan or hardship distribution, it's important to exhaust all other alternatives including taking out a personal loan. Remember, this is borrowing against a secure retirement in the future to pay for expenses today, which is not a good practice.
For example, if Sally Saver takes a 403b loan, then she's going to be prohibited from participating in her plan until all of the money is repaid. If her employer matches her contributions, then she's missing that benefit. If she eventually decides she cannot repay the loan, then she's going to owe income tax on the funds and pay a 10% early withdrawal penalty.
In addition, if the borrower decides to leave their employer before the loan is repaid, then they may be required to immediately repay the entire loan or be faced with tax penalties. Borrowing money from a 403b plan should not be an easy decision. In fact, it's a good idea to consult with a tax professional or lender before making this decision.
The personal loan calculators on this site allow end users to run through some scenarios using alternative sources of money, enabling them to see what the monthly payments would be under each alternative.
Plan sponsors have certain responsibilities with respect to money borrowed from a 403b account. Failure to identify and report loans that do not comply with the above rules may be deemed as a taxable distribution, which should be reported to the employee as income.
This can occur if an employee has more than $50,000 in outstanding loans with the employer, or the employee fails to make timely payments on money owed. When this occurs, the plan's sponsor must report the loan as a taxable distribution to the employee.
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