Having a 403 (b) account to save for retirement is one of the best ways to maximize profits. In some cases, employers match the contribution, making it very lucrative. A 403(b) loan means utilizing these funds before the age of 59.5. However, borrowing from it will significantly reduce your retirement savings.
What makes 403(b) most lucrative is that it is pre-tax money that is contributed to your retirement. In other words, your contributions are not taxed. The rest of your income falls in a tax bracket. Now, when you take out a loan, it will be taxed, and the repayment of the loan will be made using taxed money, too. This makes taking a loan highly disadvantageous for you.
What Is Maximum 403(b) Loan Limit?
The employer may set up additional restrictions. The usual IRS guidelines on the maximum loan limit are 50% or up to $50,000. Usually, for an employer contributed retirement plan, the employer may set up additional terms and conditions regarding loans. These can include repayment time, reason for borrowing the loan, and interest rate.
Acceptable Reasons To Borrow From 403(b)
The acceptable reasons to do a withdrawal from 403(b) that won’t incur a penalty during repayment include the following major reasons:
- Taking a loan for first time home purchase.
- Borrowing 403(b) funds for medical and health related expenses.
- Loaning from 403(b) plan for educational expenses.
How To Take 403(b) Loan?
Taking a loan from money stored in a 403(b) savings plan is not difficult. You just need to contact your plan provider and provide your details. They will ask the necessary questions and complete the paperwork, and you are all set.
Remember that some plans also bind you to the job. If you have borrowed the loan and have lost your current job or jumped to a new job, you will have to pay the penalty and repay the loan earlier than expected.
What Will Be The Interest Rate On 403(b) Loan?
The interest rate of loan repayment is prime rate + 1%.
The interest rate for 403(b) loans is lower than that of ordinary bank loans, which may seem beneficial in an emergency. However, this is not true. The money you get back is much more than the one you borrowed. The repayment amount will include the original amount plus taxes and penalties. The taxes are doubled because you repay with taxed money as well as you pay tax on borrowed money.
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How Can You Repay The 403(b) Loan?
Most people repay the 403(b) loan in a few years. However, studies and our past observations show that young contributors in their 20s take a large percentage out of their small contributions. This, combined with student loan debt, makes it hard for them to repay.
Usually, 403(b) plans allow up to 5 years to repay the loan. In some cases, a grace period is given, and extended repayment time is provided; for example, if buying a house for the first time, some plans allow up to 15 years.
Advantages of 403(b) Loan
The most obvious advantage is that you are taking money from yourself, so it is much easier. If we compare it with the option of taking an ordinary loan from a bank, it is pretty easy. Sometimes, the interest rate on repayment is lower than that of a credit card.
Disadvantages of 403(b) Loan
If you borrow from a 403 account and take a loan before 59.5 years of age, you will have three disadvantages. You will have to pay a penalty (10% in most cases). You will have to pay taxes on your contributions for repayment, significantly reducing the total sum. The compounding effect on savings will be lost.
Double taxation is a major issue as you will pay twice the tax on borrowed money, both on loans and on repaid money.
Taking a loan out of your 403(b) will also significantly decrease your retirement earning growth. While you are repaying the loan, you won’t be contributing to the plan. This is the most common case, as the majority of payments come from payroll.
Usually, all borrowers have the good intent of paying back as quickly as possible and returning to the track. However, we haven’t seen this happen as often.
How To Avoid 403(b) Loan Penalty?
To avoid loan penalties on 403(b) loans, certain conditions should be met.
In case of disability and certain life threatening problems, you may be exempted from paying the penalty. If you are buying a home for the first time, you may get an exemption on the penalty. Educational expenses are also exempted from loan penalties.
The bottom Line – Should I Take A 403(b) Loan or Not?
It is a bad decision, and to avoid taking a loan, you should always have better options ready. The best option is to set aside an emergency fund for 3 to 6 months. Otherwise, look for a friend or family member who can trust you enough to give you a loan.
If you don’t have any of these options, you can take out funds from the 403 (b) plan. However, taking a loan only for an emergency and not to buy a house will significantly impact the compounding factor of a retirement investing plan.
As per research, 90% of borrowers repay the loan in 5 years. Only 10% default and are unable to repay. In case of defaulting against your 403(b), it becomes a withdrawal and will cost you 10% of the penalty. Moreover, you will have to pay taxes on withdrawal based on your current income bracket.
