When an unexpected expense arises, you can consider borrowing from your retirement account. Most qualified retirement plans, such as 401(k) and 403(b) plans, offer employees the option of borrowing from their own retirement savings and paying back that amount plus interest over time.
Borrowing from a retirement account is a big decision, however, that can impact your long-term financial health. Consider both the pros and cons detailed below before committing.
A financial advisor could help you plan for your retirement and choose strategies that match your financial goals. Find a qualified advisor today.
What is a 403(b) savings account?
A 403(b) savings plan is a retirement account offered by public schools, churches, and tax-exempt organizations. Similar to the 401(k) savings plan Accessible to employees in the private sector, the 403(b) plan allows participants to save for their retirement through salary deductions and to benefit from employer matching.
Your 403(b) plan has the same limits on annual dues such as 401(k) plans. If your employer offers both a 403(b) and 401(k) savings plan, you can contribute to both, but your combined contributions for the year cannot exceed the annual limit.
When can you borrow from a 403(b) account?
It is important to note that not all 403(b) savings plans include a provision allowing you to borrow from your retirement account. You must first check with your plan administrator that this is even an option. Second, you can only borrow from a 403(b) plan with your current employer – leftover savings from a previous employer are not eligible for loans.
403(b) loans are different from normal bank loans, which might explain why you’re considering borrowing from your retirement account. There is no credit check or requirement, and interest rates for 403(b) loans can often be significantly lower than those offered by a bank for a private loan. According to Integrity Wealth Advisors, the typical interest rate for a 403(b) loan is preferential rate plus 1%. The loan amount is not taxable either.
To qualify for a 403(b) loan, you must meet certain criteria:
the maximum loan amount is 50% of your acquired account balance or $50,000, whichever is less.
In fgeneral you must repay a plan loan within five years and make repayments at least quarterly. If you are using the 403(b) loan to purchase a primary residence, the terms of your loan can extend up to 15 years.
Yes you leave your current company, you may need to repay the entire outstanding balance at one time. If you don’t, the IRS will consider it a distribution and the loan amount may be subject to the 10% rate. early withdrawal fee as well as income tax. You may also have the option of transferring the outstanding loan balance to another qualifying retirement plan.
Some plan administrators only allow you to borrow from a 403(b) account for special circumstances. These reasons may be limited to buying or repairing a home, tuition, medical or funeral expenses, and debt repayment.
What should you consider before taking out a 403(b) loan?
Although 403(b) loans are much easier to obtain than traditional bank loans, you should consider all the pros and cons before calling your plan administrator.
Benefits of borrowing from your 403(b) savings plan include:
Borrowing facility. There are rarely any loan paperwork to complete and you can access your borrowed funds in as little time as it takes the bank to transfer them.
Low interest rate. The interest rate is often only 1% above the prime bank rate, which is significantly lower than most personal loan rates and credit card interest rates.
Interest counts as a contribution. In many plans, the interest from the 403(b) loan actually counts as a contribution to your plan, and so your loan payments will continue to add to your account balance over time. Unlike private loans or credit cards, the interest you pay does not go to the financial institution.
Double taxation. Most 403(b) contributions are pre-tax deferrals. However, you will repay your 403(b) loan with after-tax money. When you retire and receive distributions from your 403(b) savings plan, you may also pay income tax on that total amount. So if you take out a 403(b) loan, you pay the amount back with after-tax money, and then pay income tax on your distribution – basically, you’re paying taxes for the same amount twice at the course of your life.
Loan default terms. If you do not repay your loan as agreed, the full amount of your 403(b) loan will be taxed as income and you may also pay a 10% early withdrawal fee.
Opportunity cost. By borrowing money from your retirement account, you will lose any investment returns you may have earned over the same period. It might be worth comparing the interest rate on your 403(b) loan with the potential returns, and if your average annual investment returns are much higher than your interest rate, you could be losing significant revenue.
An alternative to consider could be a Substantially equal periodic payment (SEPP) for your 403(b). SEPP schemes are not loans but a method of distributing retirement funds without penalty before the age of 59½. They aren’t eligible for use with your current employer’s 403(b) plans, only for legacy accounts or IRAs, and are best suited for people who need to draw down their retirement funds sooner.
There may be times when you consider taking out a loan through your 403(b) savings plan. It is relatively easy to borrow from your pension fund and you can pay a low interest rate for the loan. However, repayment terms are often limited and you could lose potential income over the life of your loan. You should always consider the pros and cons associated with borrowing from your retirement savings before committing.
Retirement Planning Tips
Not sure if borrowing from your retirement savings will hurt your retirement plans? For solid financial advice, consider speaking with a qualified financial adviser. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors at no cost to decide which one is best for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
Photo credit: ©iStock.com/sefa ozel, ©iStock.com/Eugene Zvonkov, ©iStock.com/Tero Vesalainen