Interest Rate on Non-ERISA 403(b) or 457(b) Loans

Q. Is there a requirement that for non-ERISA Section 403(b) or Section 457(b) loans, the interest rate on the loan must be Prime plus 2%?

A. The interest rate requirement for all loans is that the rate be “reasonable.” In a webinar that they did about three years ago, the IRS indicated that the interest rate on loans should be Prime plus 2% on a loan, which caused the chaos. They included a caveat that that if the investment company or TPA could justify a lower rate, that would be accepted on audit as well. The IRS did not distinguish between ERISA and non-ERISA plans.

Many firms, in addition to offering the Prime plus 2%, will also compare it to the “average rate” for the type of loan requested. For example, if the loan is for a principal residence, the average mortgage rate for a national bank can be used or if it is a loan for any other reason, the average rate for a personal loan that is from a national bank or from a lender in the participants location can be used. In most case this would be less than Prime plus 2%. Most TPAs adjust the “average rates” monthly and use those for loan interest rates, which the IRS will accept on audit.

Can you use the Prime rate or Prime +1%? Probably; you just need to justify that it is a “reasonable rate.”