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403(b) Loans

Last updated 25th Nov 2022
Under certain conditions, it's possible to obtain a loan from a 403(b) 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, the distribution will be reported as income, and if the accountholder is under age 59 1/2, then a 10% tax penalty may apply.

403(b) Loan Limitations

If an employer's 403(b) 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, the loan may be deemed a distribution. Additional tax penalties may apply if the accountholder is not age 59 1/2 or older. The bulleted list below summarizes the rules to follow to stay clear of the early distribution penalties:
  • The 403(b) plan, or the tax-sheltered annuity, must provide for loans.
  • The limit on all loans, at any time, 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 loan may not exceed five years, unless the money is used for the purchase of a principal residence.
  • * Finally, the loan must bear a reasonable rate of interest.
If an individual fails to pay the amount due, or defaults on a loan, the Internal Revenue Service (IRS) will treat the entire loan (not just the remaining balance) as a distribution. In that situation, the 10% early withdrawal penalty will apply.

Hardship Distributions

It is possible to obtain a hardship distribution from a 403(b) 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 403(b) 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:
  • 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 a primary residence.
403b loans
The above list of hardship withdrawals is 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.

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. 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 403(b) loan). Participants will likely be prohibited from contributing to their plan for six months. Finally, it's not possible to perform a 403(b) rollover into another retirement plan or IRA using the money from a hardship distribution.

Borrowing Money from a 403(b)

Before making any decision to borrow from a 403(b) 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 403(b) 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, they may be required to immediately repay the entire loan or be faced with tax penalties. Borrowing money from a 403(b) 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.

Sponsor Rules

Plan sponsors have certain responsibilities with respect to money borrowed from a 403(b) 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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