403(b) plan loans vs. 403(b) hardship distributions

In our discussions with districts over the last few years, we’ve learned there is confusion about the difference between loans and hardship withdrawals—and in some cases, they are thought to be the same.

Loans and hardships do have one thing in common: the district has control over whether or not to offer either or both as a 403(b) withdrawal option for their employees.

However, loans and hardships are two distinct plan provisions.

  • At a high level, loans are just what you would think: the employee receives cash from their 403(b) plan with a repayment schedule attached to that distribution.
  • A hardship is a withdrawal that the employee takes due to a personal financial situation that qualifies as a hardship. An employee who takes a hardship withdrawal is presumed not to be able to pay that money back to their account.

Let’s take a closer look at the plan administration issues that surround loans as compared to hardship distributions.

Loan issues

Issue 1: Multiple vendors.

Many schools have multiple vendors in their plan. However, the IRS has one limit for loans. This one limit applies to all accounts that an employee may have with all vendors under the plan. There is not a separate limit for each individual vendor.

For example: Let’s assume you have an employee who has an account with Company A that has a $100,000 account value and an account with Company B with an account value of $120,000. The maximum loan amount allowed under the IRS regulation is 50% of the account value not to exceed $50,000 at any one time.

In the eyes of the IRS, this employee would have $50,000 in loans available. However, if companies A and B are not aware that the employee has both accounts, they may both allow a $50,000 loan. This would be a plan audit problem as the employee’s total loan balances would be $100,000, exceeding the $50,000 limit.

Issue 2: Risk.

Loans are a long-term risk that will be on the books of the district’s plan due to repayment schedules. If the loan is used to purchase a primary residence, it could last as long as 25 years.* If an employee has an outstanding loan and leaves the district, the loan is generally required to be paid in full either immediately or within 60 days. 

Districts offering loans will want to set up a process to track loans and make sure that information is passed along to vendors when an employee is no longer employed by the district.

*NOTE: The WEA TSA Trust 403(b) program only allows for personal loans (not mortgage loans) which requires a five year payoff. Some 403(b) providers may offer the mortgage option with extended pay off schedules.

Hardship issues

Although hardship distributions are not long-term concerns like loans, they still pose audit risks. As an employer, you’re responsible for allowing an employee to take a hardship withdrawal for the following reasons only:

  • Unreimbursable medical expenses for self, spouse, children, dependents, and primary beneficiary.
  • Purchase of a primary residence.
  • Tuition for post-secondary tuition and education related expenses for self, spouse, children, dependents, and primary beneficiary.
  • Prevention of foreclosure or eviction from primary residence.
  • Funeral expenses for immediate family, including primary beneficiary.
  • Repair of damage to primary residence that qualifies for casualty tax deduction.

To make sure they qualify, the employee needs to provide documentation that they have met at least one of the criteria above to take the withdrawal. They are only allowed to withdraw employee contributions and the amount necessary to cover the hardship; the amount can be increased to cover taxes and penalties if applicable.

In addition, the employee must stop contributions to all vendors for the six months following the hardship. If the employee wants to take any additional hardship withdrawals, the process must be followed separately for each request. With hardships, the compliance risk generally does not go beyond the six-month stop of contributions.

The key differences

The key differences between loans and hardship plan risks are:

  1. The amount of time that a loan is required to be administered.
  2. The need to monitor loans for limits and employment status.
  3. The need to determine if an employee qualifies for a hardship.
  4. The requirement to stop contributions for six months once a hardship is taken.

These are the main points of concern with these plan withdrawal provisions. You will want to consider the decisions you have made with your plan set up and whether they are the best options for you and your employees.

If you need help understanding these and other 403(b) plan set up decisions, please contact a Plan Administration Consultant at 1-800-279-4030, Option 3.

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