403b loan question

[Guest Jphagg]

Hello.

I have an employee who took a 403b loan last year and now is considering defaulting on the loan.

He is having trouble making payments .

I do know that his wife is in Grad school- could he change the loan

Into a hardship distribution for her tuition?

Thank you for any answers I can give him.

[ETA Consulting LLC]

No, he cannot. The hardship rules pertain to an immediate need where the individual must take all 'available' loans prior to receiving the hardship. When he defaults, he'll have the 10% early withdrawal penalty to contend with if he is not a age 59 1/2 or meet another exception. Remember, qualified higher education expenses aren't an exception to this penalty from qualified plans or 403(b)s, but are an exception from IRAs.

Depending on the loan amount and the loan term, he may be able to try to structure a loan with payments spreaded out over 5 years. This will require detailed calculations on loan availability (again, depending on the loan amount and loan term of the current loan).

Good Luck!

[masteff]

I do know that his wife is in Grad school- could he change the loan

Into a hardship distribution for her tuition?

As said above, he can't "change" the loan. But nothing in the world to say he can't take a valid hardship distribution (assuming the plan provides for such and he otherwise qualifies) and in a completely unrelated transaction repay his loan in a lump sum payment. Be sure you get proper documentation to support the hardship distribution. (Note: and having an existing loan is generally a requirement for a hardship so we already know he's got that requirement covered!)

[jpod]

I am not seeing the reason to take a taxable distribution to avoid a taxable deemed distribution.

[ESOP Guy]

I have a little problem with the idea of an ee choosing to default on a loan.

I think one needs to go back and read the promissory note. In every TPA firm I have worked for the promissory note is clear that as a condition of the loan the person is agreeing to have the payment come from their check via payroll deduction.

I have always had mixed feelings regarding one party in effect declaring the contract null and void like that.

So my comment assumes in this case the promissory note has that language in it. If it doesn’t obviously my comment doesn't matter.

And not being an expert in contract law maybe someone can just refuse to up hold their end of a contract and the breach in this case might be the loan become due at the point of breach. And that has the same result.

I guess what I am saying is I think there may be a consideration(s) outside of mere qualified plan law one might want to look at.

I think there have been threads on this issue before, some not that long ago even.

But since ESOPs basically never have loans like we are talking about and it has been a while since I really worked 401(k)s etc with lots of loans I fully admit at this NOT being an area of expertise of mine.

[masteff]

I have a little problem with the idea of an ee choosing to default on a loan.

As do some other members of the board... it's been kicked around a few times: http://benefitslink.com/boards/index.php?showtopic=48358 If I remember correctly, part of the argument to allow it has to do with state's laws and payroll deductions, but then the can of worms really opens up with preemption, bankruptcy law, etc.

[K2retire]

I am not seeing the reason to take a taxable distribution to avoid a taxable deemed distribution.

Perhaps to avoid being defaulted. If the plan has a rule that you can't have another loan once you've defaulted it could be an issue.

[MARYMM]

I am not seeing the reason to take a taxable distribution to avoid a taxable deemed distribution.

Perhaps to avoid being defaulted. If the plan has a rule that you can't have another loan once you've defaulted it could be an issue.

The hardship distribution also removes the requirement for repayment - which seems to be the issue for this employee.

But I agree with those questioning how an employee can "decide to default" since payments are usually via payroll deduction...