Many people in the higher education sector view their 403(b) plans as their largest retirement asset. It really should come as no surprise, either. Most colleges and universities generously contribute to employer retirement plans. Many people will consider borrowing from their savings account at some point. This article will explain how 403(b) loans operate, their benefits and drawbacks, and whether you should use one.
What is a 403(b) Loan?
A 403(b) loan allows you to borrow money from your own 403(b) account in order to access it. Most of us associate loans with financial institutions giving you money that you must repay over a predetermined period of time. You can access your own money, which is typically set aside for retirement, through 403(b) loans. Traditionally, you wouldn’t be able to access these funds until you were 59 1/2. However, if you take out a loan, you can access these funds without having to worry about paying any early withdrawal fees.
How a 403(b) Loan Works
First things first, not all plans allow for loans. Most do, but to be certain, you’ll need to speak with your HR department or plan provider. To be certain, request the Summary Plan Description from your HR contact if they are unsure.
How much can I borrow?
Most plans permit you to borrow up to $50,000 or 50% of your account’s vested balance. You cannot borrow from your vested company match in all plans. Some plans only permit borrowing against your vested contributions.
How do I borrow?
The straightforward and straightforward application procedure for 403(b) loans is one of the reasons they are popular. Call your plan’s provider and ask for a loan if one is appropriate for you. If the plan allows, you might have the money in your possession in a matter of days. Comparing this to going to a bank to get a loan is much easier.
What will the interest rate be?
Typically, the interest rate is the prime rate plus 1%. This means you could potentially get a 403(b) loan with a reasonable interest rate.
How is it paid back?
The term of 403(b) loans normally cannot exceed 5 years. If you use the loan to purchase a home, there is a provision that may allow you to repay over a 15-year period.
Loan payments must be made at least once every three months or more frequently. Some plans permit a brief grace period during which you are exempt from making payments.
Once a strategy is established, you’ll make equal payments throughout the loan’s term. The payments will come out of your paycheck. This indicates that you are using post-tax funds to pay back the loan. These terms are normally non-negotiable once the loan is granted. But if you can, many plans will let you pay off the loan all at once.
Pros of 403(b) Loans
Easy to Obtain – Compared to borrowing money from a local bank or credit union, 403(b) loans are a lot simpler to obtain. A 403(b) loan does not require complicated loan origination paperwork or extensive credit checks.
Low interest rate – A 403(b) loan may be a good choice if you find yourself in a bind financially. The interest rate should be a third of what you would pay on a credit card, if not a quarter.
Most plans allow the interest you pay to actually go into your account, which means that the interest builds YOUR account. This indicates that your loan payments are continuing to build your account. With typical bank loans, the financial institution keeps the interest you pay.
Cons of 403(b) Loans
Double taxation – You pay pre-tax money into your 403(b) plan when you contribute to it. However, if you take out a loan, the repayment is deducted from your post-tax paycheck. When you eventually withdraw money from your 403(b), you’ll be required to pay income tax on the full amount. You are essentially taxed twice on the loan amount if you repay a loan with after-tax money and then later pay income tax on your subsequent distributions.
Better avoid defaulting because doing so will result in taxation of the entire loan amount as a distribution and, if you are under 59 12, a 10% penalty. If you leave a job with an outstanding loan, you might have to pay right away to stay out of default.
Opportunity Cost: Due to personal financial concerns, professors are delaying retirement. In light of this, taking out loans against your 403(b) may prevent your retirement savings from growing. The compound interest that fuels the growth of your assets will not be applied to the loan amount. Your assets may not fully benefit from the market recovery if you take the loan at the unfortunate time of a down market.
Should You Take a Loan from your 403(b) Plan?
I generally believe it to be a bad idea. A cash reserve of anywhere between three and six months’ worth of expenses is recommended by sound financial planning. If you come into a pinch, start with cash reserves.
I believe using a 403(b) loan is acceptable if you don’t have an emergency fund or your only choice is to charge a sizable sum on credit cards. Although it’s not ideal, you also don’t want to have high-interest credit card debt.
The main factor to think about is how it will affect your retirement savings. Young people frequently use these loans to purchase their first home. I am strongly against this idea. Save money for a down payment on a house that isn’t part of your retirement plan. A young person’s (or anyone’s) best friend in a retirement plan is compound interest. Avoid stifling the growth of your retirement savings. Putting off investing until you are nearing retirement age makes it more challenging to build up a sizable savings. Invest early and often when time is on your side.
You now understand how 403(b) loans operate. Not everyone can benefit from them, but if you do decide to use one, it’s important to be informed.
Securities America and its representatives do not provide tax advice; therefore it is important to coordinate with your tax advisor regarding your specific situation.
Is it a good idea to borrow from your 403 B?
There might be times when you’re thinking about borrowing money from your 403(b) savings account. It is fairly simple to borrow money from your retirement account, and you might only have to pay a small amount of interest. Although repayment terms are frequently short, you might be losing out on potential income during the loan period.
Is it better to get a loan or withdrawal from 401k?
You can take out a loan from your retirement funds and repay it over time with interest; the loan payments and interest are credited back to your account. Withdrawals permanently remove funds from retirement accounts for use now, but they come with additional taxes and potential penalties.
How can I withdraw from my 403b without penalty?
- Reach age 59 1/2.
- Have a severance from employment.
- Become disabled.
- Encounter a financial hardship.
- Die (beneficiaries will be able to make withdrawals)
What happens if I don’t pay back my 403b loan?
The amount you don’t pay back on your loan after leaving UC is regarded as a distribution. That implies that you will be required to pay federal income tax (and, in most cases, California state income tax) on that sum. If you’re younger than age 59. 5, a 10% early withdrawal penalty (2. 5% State) may also apply.