When an unexpected expense comes up, you might consider borrowing from your retirement account. Most qualified retirement plans, such as 401(k) and 403(b) plans, offer employees the option to borrow from their own retirement savings and repay that amount plus interest over time.
Borrowing from a retirement account is a big decision, though, potentially impacting your financial health long-term. Consider both the advantages and disadvantages detailed below before committing.
A financial advisor could help you plan for retirement and select strategies that align with 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 available to private-sector employees, the 403(b) plan allows participants to save money for retirement through payroll deductions and benefit from employer-contribution matches.
Your 403(b) plan has the same caps on yearly contributions 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?
Importantly, not all 403(b) savings plans include a provision that allows you to borrow from your retirement account. You must first verify with your plan administrator that this is even an option. Secondly, you can only borrow from a 403(b) plan at your current employer–leftover savings from a previous employer are not eligible for loans.
403(b) loans differ from normal bank loans, which might be why you’re considering borrowing from your retirement account. There is no credit check or requirement, and 403(b) loan interest rates can often be substantially lower than those offered by a bank for a private loan. According to Integrity Wealth Advisors, the typical 403(b) loan interest rate is the prime rate plus 1%. The loan amount is not taxable either.
In order to qualify for a 403(b) loan, you must meet certain criteria:
- The maximum loan amount is 50% of your vested account balance or $50,000, whichever is less.
- Generally you must repay a plan loan within five years and make repayments at least quarterly. If you use the 403(b) loan to purchase a primary residence, your loan terms may extend to 15 years.
- If you leave your current company, you may be required to repay the full outstanding balance all at once. If you do not, the IRS will consider it a distribution and the loan amount may be subject to the 10% early withdrawal fee as well as income tax. You may also have the option to roll over the outstanding loan balance to a different, eligible retirement plan.
- Some plan administrators may only allow you to borrow from a 403(b) account for specific circumstances. These reasons may be limited to buying or repairing a house, paying for schooling, paying for medical or funeral expenses and paying off debt.
What Should You Consider Before Taking 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.
Advantages to borrowing from your 403(b) savings plan include:
- Ease of Borrowing. There is rarely any loan paperwork to fill out and you can have access to 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% higher than the base bank rate, which is notably lower than most personal loan rates and credit card interest rates.
- Interest Counts as a Contribution. In many plans, the 403(b) loan interest actually counts as a contribution to your plan, and so your loan repayments will continue to grow your account balance over time. Unlike with private or credit card loans, the interest you pay does not go to the financial institution.
- Double Taxation. Most 403(b) contributions are pre-tax deferrals. However, you will pay back your 403(b) loan with post-tax money. When you retire and take distributions from your 403(b) savings plan, you may also pay income tax on that full amount. So if you take a 403(b) loan, you pay back the amount with post-tax money and then pay income tax on your distribution–in essence, paying taxes for the same amount twice over your lifetime.
- Loan Default Terms. If you don’t pay back your loan as agreed, your entire 403(b) loan amount 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 out on the investment returns you could earn over that same time period. It could be useful to compare your 403(b) loan interest rate against the potential returns, and if your average annual investment returns are much higher than your interest rate, you could be losing out on significant earnings.
One alternative to take into account could be a Substantially Equal Periodic Payment (SEPP) plan for your 403(b). SEPP plans are not loans but a method of distributing retirement funds without penalty prior to age 59 ½. They are not eligible for use with 403(b) plans at your current employer, only for past accounts or IRAs, and are best suited for individuals who need to tap their retirement funds early.
There may be times when you are considering taking a loan from your 403(b) savings plan. It is relatively easy to borrow from your retirement fund, and you may pay a low interest rate for the loan. However, repayment terms are often limited and you could be losing out on potential earnings over your loan period. You should always consider both the pros and cons associated with borrowing from your retirement savings before committing.
Retirement Planning Tips
- Not sure whether borrowing from your retirement savings will hurt your retirement plans? For solid financial advice, consider speaking with a qualified financial advisor. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s free retirement calculator to get a good estimate of how much money you’ll need to retire.
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