Can I Borrow From My 457 to Buy a House?

A 457 plan is a deferred compensation retirement plan available to public sector employees and some non-governmental tax-exempt organizations. These plans allow employees to save for retirement on a tax-advantaged basis, often by deferring a portion of their income. Like other employer-sponsored retirement plans, 457 plans offer tax-deferred growth on contributions and earnings until withdrawal. While their primary purpose is retirement savings, some 457 plans may permit participants to borrow funds under specific conditions.

Eligibility and Purpose of 457 Plan Loans

Whether you can borrow from your 457 plan depends on the plan’s type and specific provisions. Governmental 457(b) plans, offered by state and local government employers, typically allow for participant loans. Non-governmental 457(b) plans, sponsored by tax-exempt organizations, generally do not permit loans. The availability of a loan is ultimately determined by the individual plan document, rather than being a universal feature of all 457 plans.

To be eligible for a loan, participants must be actively employed and have a vested account balance. Plan documents may also specify a minimum account balance for loan eligibility. A common reason for taking a retirement plan loan is for the purchase of a principal residence. This purpose often allows for a longer repayment period compared to other types of loans.

Specific Terms and Conditions for Borrowing

When borrowing from a 457 plan, the loan amount is subject to federal limitations. The maximum amount a participant can borrow is generally the lesser of $50,000 or 50% of their vested account balance. This $50,000 limit is reduced by the highest outstanding loan balance from any qualified employer plan over the preceding 12-month period.

The repayment period for a 457 plan loan is typically limited to five years. However, loans used to purchase a primary residence may allow for a longer repayment term, potentially up to 15 or even 30 years. Interest rates for these loans are usually set at a reasonable commercial rate, often based on the prime rate plus a small percentage, and the interest paid is returned to the participant’s own account. Loan origination or administration fees may also apply. Repayment is typically facilitated through automatic payroll deductions, ensuring consistent payments.

Tax Implications of 457 Plan Loans

A properly structured and repaid loan from a 457 plan is generally not considered a taxable distribution. This means you do not pay income tax on the loan amount when you receive it, provided it adheres to IRS rules.

If the loan fails to meet certain requirements or is not repaid according to its terms, it can become a “deemed distribution.” This occurs if the loan exceeds the maximum allowable amount, if payments are not made at least quarterly, or if the repayment period is violated. A deemed distribution results in the outstanding loan balance being treated as taxable income to the participant, subject to ordinary income tax rates. If the participant is under age 59½, a 10% early withdrawal penalty may apply. Even after a deemed distribution, the loan obligation to the plan remains, and the participant is still required to repay the loan.

Managing Your 457 Loan Repayment

Effective management of a 457 plan loan is crucial to avoid negative tax consequences. The standard repayment method involves regular, automatic payroll deductions, which helps ensure timely payments and minimizes the risk of default. Loan payments are typically made with after-tax dollars. Consistent repayment is essential, as failure to make payments can lead to a deemed distribution, triggering immediate taxation.

If employment terminates while a loan is outstanding, the repayment terms often change. Many plans require the full outstanding balance to be repaid more quickly. If the loan is not repaid by the specified deadline, the outstanding balance can be treated as a taxable distribution. Participants may have options to continue repayment or roll over the outstanding loan amount to another eligible retirement plan to avoid immediate taxation.