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dmcgrew

Default On 403b Loan

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Hello,

I read the 403b-wise article on 403b loans. I found it to be informative, but I really need more information. I defaulted on my 403b loan. I have paid all the penalties and whatever else the government could get out of me for the default. I contacted the company with whom I have the 403b plan, and inquired why the loan still shows on my statement, and is still increasing in interest. I was told that this will continue until I quit my job or retire and that I do not need to worry about it. I will not have to pay it back.

I was also told that I can not pay it back because the loan is defaulted.

This makes me nervous because, why are they still keeping track of it, if it is something that I will not be held responsible for in the future.

Could you please fill me in on what I have gotten myself into and how should I handle it from here?

Thank you,

DMcGrew

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I have paid all the penalties and whatever else the government could get out of me for the default.

 

I was also told that I can not pay it back because the loan is defaulted.

 

To confirm, you defaulted on the loan and the government "dinged" you for income tax plus 10%? If that is true, then the loan should net-out of the 403b and no longer exist. Unless there is something hidden in the Plan Document about loans, you need to have the company record the loan as a withdrawal so it no longer accrues interest. Sorry, just something about "don't worry about it" that makes me worry more about it. Without having "client does not have to pay back accrued interest" in writing, I'd keep pushing them.

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I have paid all the penalties and whatever else the government could get out of me for the default.

 

I was also told that I can not pay it back because the loan is defaulted.

 

To confirm, you defaulted on the loan and the government "dinged" you for income tax plus 10%? If that is true, then the loan should net-out of the 403b and no longer exist. Unless there is something hidden in the Plan Document about loans, you need to have the company record the loan as a withdrawal so it no longer accrues interest. Sorry, just something about "don't worry about it" that makes me worry more about it. Without having "client does not have to pay back accrued interest" in writing, I'd keep pushing them.

 

Thank you for your prompt response. I called the company from whom I have my plan and managed to speak with a person who was very knowledgeable of the loan process, this time.

She said that this is done so my records indicate that I still have a loan outstanding, so they won't issue me another loan unless I pay it off. It will continue to accrue interest for the life of the loan (5 years) then it will just be on my statement.

I do not have to pay the interest, ever, if I just ignore it, since this is interest I was paying to myself.

So my choices are to ignore it, or pay it off, in one lump sum, if I want to take out another loan.

This still does not leave me with a comfortable feeling, but seems to make sense.

As to something in writing about the interest, she said that it's the law and they can not make me pay it back.

Thank you for your advise,

dmcgrew

 

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Actually, defaulting on a plan loan is a complicated matter that's addressed in the income tax regulations. When you default on a loan, you receive a Form 1099-R that represents a taxable event. You have to pay taxes and appropriate penalties on the amount of the defaulted loan. However, since no cash is received on a default, the IRS refers to it as a "deemed distribution." This means that you have to include the defaulted loan in gross income, as just discussed.

 

Because of the restrictions of section 403(b)(11), the plan cannot reduce your account balance by the amount of the defaulted loan. This can only take place when you sever employment, attain age 59½, die or become disabled. When one of these qualifying events occurs, only then can the loan principal be reduced to zero. That is known as an "offset distribution," since the account balance is reduced to offset the amount of the loan.

 

Until this offset distribution takes place, the loan amount has to remain on the account, even though you've included it in your gross income and paid tax on it. With some companies, the loan continues to accrue interest. Hopefully, the account value that's securing the loan is accruing interest at a greater rate. Regardless, only when one of the qualifying events listed earlier occurs will the loan and accrued interest be deducted from the account.

 

Moreover, while the loan is intact, it will impact your ability to take additional loans. And, since you defaulted on the original loan, you will have to make special arrangements to repay any new loan.

 

 

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Because of the restrictions of section 403(b)(11), the plan cannot reduce your account balance by the amount of the defaulted loan. This can only take place when you sever employment, attain age 59½, die or become disabled.

 

Thank you for pointing out the specifics on the issue I did not know that!

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Guest Sierra

Actually, defaulting on a plan loan is a complicated matter that's addressed in the income tax regulations. When you default on a loan, you receive a Form 1099-R that represents a taxable event. You have to pay taxes and appropriate penalties on the amount of the defaulted loan. However, since no cash is received on a default, the IRS refers to it as a "deemed distribution." This means that you have to include the defaulted loan in gross income, as just discussed.

 

Because of the restrictions of section 403(b)(11), the plan cannot reduce your account balance by the amount of the defaulted loan. This can only take place when you sever employment, attain age 59½, die or become disabled. When one of these qualifying events occurs, only then can the loan principal be reduced to zero. That is known as an "offset distribution," since the account balance is reduced to offset the amount of the loan.

 

Until this offset distribution takes place, the loan amount has to remain on the account, even though you've included it in your gross income and paid tax on it. With some companies, the loan continues to accrue interest. Hopefully, the account value that's securing the loan is accruing interest at a greater rate. Regardless, only when one of the qualifying events listed earlier occurs will the loan and accrued interest be deducted from the account.

 

Moreover, while the loan is intact, it will impact your ability to take additional loans. And, since you defaulted on the original loan, you will have to make special arrangements to repay any new loan.

 

 

Michael,

 

Where a defaulted loan has been reported as a taxable event with the taxes due paid in full, why doesn't the IRS grant an exemption from section 403(b)11 and allow the former creditor to effectuate an offset distribution?

 

Peace and Hope,

Joel

 

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Joel,

 

Before the IRS issued temporary, then final regulations for section 72(p), the issues of deemed and offset distributions were discussed in earlier notices issued in the mid-90's. When issuing those notices, the IRS stated that they are not empowered to allow a distribution prior to a qualifying event to offset a loan because it's contrary to the provisions of 403(b)(11) and only Congress can change the language of the Internal Revenue Code.

 

So, it appears that it will take "an act of Congress" to simplify the somewhat confusing matter of deemed and offset distributions. Another fine example of your tax dollars at work. :^)

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Guest Sierra

Joel,

 

Before the IRS issued temporary, then final regulations for section 72(p), the issues of deemed and offset distributions were discussed in earlier notices issued in the mid-90's. When issuing those notices, the IRS stated that they are not empowered to allow a distribution prior to a qualifying event to offset a loan because it's contrary to the provisions of 403(b)(11) and only Congress can change the language of the Internal Revenue Code.

 

So, it appears that it will take "an act of Congress" to simplify the somewhat confusing matter of deemed and offset distributions. Another fine example of your tax dollars at work. :^)

 

 

Also, another fine example of one's union dues at work. Shame on them for not lobbying for such an exemption.

 

Joel

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