How Do 403(b) Plans Treat Loans When a Participant Requests a Distribution?

Q: We work with an ERISA 403(b) plan which allows for loans. What happens to the loan when a participant requests a distribution of his/her account balance?

Kimberly Boberg, Kelly Geloneck, Emily Gerard and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: The answer to this question is dependent on the plan’s loan policy and/or loan provisions in the plan document. Some 403(b) plans, permit a participant to continue to make loan repayments following termination of employment, and the participant can withdraw the remaining account balance that is not securing the loan. However, some plans require full repayment of the loan upon termination of employment or in the event of the participant’s request for a distribution. In that case, if full repayment is not made, the loan is generally offset against the retirement plan account balance, and that loan amount becomes a taxable distribution in addition to any other distribution that is taken. See Tres. Reg. §1.72(p)-1, Q&A-13. Note that this loan offset is treated as an actual distribution as opposed to a deemed distribution, which is what normally occurs with a defaulted loan. Id; See also Tres. Reg. §1.72(p)-1, Q&A-10. For more on loan offsets, check out this IRS webpage. The experts also note that in some cases loans may be “contract” loans from plan funding vehicles which could have separate rules and processes.

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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