Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:
Excellent question! Actually the tax treatment is a bit different for Roth, due to the fact that the Roth contributions (and the entire balance of traditional 403(b)s converted into Roth 403(b)s) have already been taxed. As is the case with the traditional 403(b), you still receive loan proceeds without taxation, and you still pay back the loan from after-tax funds. However those funds, once restored to your account, are never taxed again.
Thus, not only are you not “double-taxed” with respect to this loan transaction, the net result is that the loan principal transaction is essentially tax neutral, since you received the loan check tax-free, made repayments from after-tax funds (these two transactions offset each other for tax purposes) and now have restored funds to your account that will never be taxable to you (presuming you are compliant with the distribution restrictions with respect to Roth contributions). And loan interest is only taxed once, not twice as was the case with a traditional 403(b) loan, since interest is paid back to a participant’s account from after-tax income, but is NOT taxed a second time upon distribution.
However, remember the issue with opportunity cost from the last Q&A? This is the cost associated with the difference between what the borrowed amount would have earned had it remained in the 403(b) account and the actual earnings on the borrowed amount (mainly, the interest charged on the loan). That difference is magnified when one borrows from a Roth 403(b), since the difference in investment return is tax-free, resulting in larger after-tax opportunity cost that would have been the case with borrowing from a traditional 403(b).
Finally, you may be wondering if you can convert a loan from a traditional 403(b) to one from a Roth 403(b). You can, but you would not improve the tax treatment, since the loan amount would be taxable immediately upon conversion.
Thanks for providing the Experts with the opportunity to discuss the often-overlooked area of loans from Roth 403(b) accounts!
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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