403(b) Loan becomes a distribution

Q. I defaulted on a loan from my 403 b account. I paid the taxes on the distribution. I am 64 years old & still working. Do I still have to pay back the loan? What happens if I pay it back? What happens if I don't pay it back?

A. (1) Most 403(b) loans have to be repaid within 5 years (30 years if used to pay for a new home). 403(b) loans are beneficial because they allow you to borrow cash from your retirement savings but do not charge taxes on the interest unless you default. As you default on the loan, the unpaid balance is treated as an early distribution from your 403(b), triggering taxes and a 10% penalty. 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. Worse, IRS restrictions on loan repayments are very severe. Missing even a single payment can trigger a loan default, and the loan cannot be reinstated.When you borrow out of your 403(b), it reduces the amount you accumulate for retirement. Even if you take out a small 403(b) loan, do not think that defaulting on it can have small consequences. Most companies treat the loan as being outside of your annuity, so the loan continues to accumulate interest until you decide to withdraw your money or the loan balance equals your annuity value. Some teachers may not realize the loan they defaulted on years ago is continuing to accumulate interest, rather than being debited against their annuity at the time of default. Unfortunately, this would really require looking at the specific contract to see what it says. If it is a governmental 403(B) plan, you'd also need to look at applicable state and local law. Whether the plan is governmental or not basically depends on whether you were a public or private school teacher. If public, it's a governmental plan, if private, it is not.You need to definitely try to get the contract.

(2) In general, when you pay back your loan with interest, you take out cash from your regular checking and savings accounts. This reduces the interest being paid on either account because the amount deposited in each account is reduced. Unless you pay off the loan, it will be seen as an early distribution from the account and you will owe federal and state income taxes along with the 10% penalty if you are under 59 and 1/2 years of age.

Source: http://www.asktaxguru.com/8161-403-b-loan-becomes-a-distribution.html