Understanding the Process of 403(b) Loans
If you're faced with an upcoming significant expense but find yourself a bit short on funds, you might be thinking about borrowing from your 403(b) account. Many 403(b) plans include a loan provision, providing temporary access to your retirement savings. However, before making this decision, there are some crucial details you should be aware of.
What is a 403(b) loan?
A 403(b) loan varies significantly from a bank loan. No credit check is required, and the terms of the loan can be more lenient than those of a personal line of credit, credit card cash advance, or even a home equity line of credit (HELOC). Essentially, you're withdrawing funds from your 403(b) with the intention of repaying them over time. As long as you repay on time, you won't be subject to the taxes and fees associated with early withdrawals.
Each plan has unique terms for its loan option, so it's essential to review the details with your plan administrator. However, the process of securing a 403(b) loan is consistent across all plans.
How does a 403(b) loan work?
To secure a loan from your 403(b), you'll need to discuss the terms with your plan administrator and sign a loan agreement. The contract should outline the interest rate and repayment schedule.
The IRS sets a maximum amount you can borrow, which is 50% of your vested account balance or $50,000, whichever is lower. If your account balance is less than $10,000, the IRS allows you to borrow the full balance. Some plans may have stricter limits.
The IRS also stipulates that the loan must be repaid in equal payments, with at least quarterly installments, and within five years. Individual plans may have more stringent requirements.
After taking the withdrawal, you should be enrolled in regular loan repayments from your paycheck, equal to the minimum payment required to meet the loan agreement terms.
Unlike regular 403(b) contributions, loan repayments do not count towards your contribution limits. The contribution limit for 2024 is $23,000, increasing to $23,500 in 2025.
Those 50 and older can contribute up to $30,500 in 2024, thanks to additional catch-up contributions. In 2025, workers ages 50 to 59 and 64 and older can contribute up to $31,000 to a 403(b) with catch-up contributions. Those between the ages of 60 and 63 are eligible for an even higher limit, with the maximum contribution in 2025 being $34,250.
The interest portion of your loan payments is made with after-tax dollars, whereas regular contributions are usually pre-tax.
If you can repay the loan early, you can discuss creating a payoff statement with the plan administrator to settle the remaining balance.
What to consider before taking out a 403(b) loan
There are several factors to consider when considering a loan from your retirement plan.
Although there is no real net interest cost since you're paying yourself interest, there is a real cost to borrowing from your savings – the lost potential returns from keeping the funds invested.
The S&P 500 averages more than 9% returns per year over five-year periods, but the possibilities can vary widely. It's impossible to predict the market's future performance, but it's more probable that the market will rise than fall, causing a cost to your loan. If you can secure a personal loan with a relatively low interest rate, it's likely a better option than borrowing from your 401(k).
Furthermore, there are tax implications to consider. The interest you pay yourself into your 403(b) account is treated as after-tax money, meaning you'll pay taxes on it now and again upon withdrawal if you're using a traditional pre-tax 403(b) account.
If your 403(b) plan offers a designated Roth account and you can take your loan withdrawal exclusively from that Roth account, you'll avoid double taxation on your interest payment. You'll pay tax on the payment but no tax upon withdrawal.
The largest risk is non-repayment. If you lose your job, you'll be required to repay the entire loan balance all at once. If you can't come up with the funds, the balance will be treated as a distribution subject to early withdrawal penalties and taxes. Consequently, the "loan" may end up costing you more than a traditional loan.
Consider all these factors when evaluating the 403(b) loan option. Like many financial decisions, a 403(b) loan has advantages and disadvantages, and the deciding factors often depend on individual circumstances.
What's the distinction between these two retirement schemes we're discussing? **#### Retirement Planning: Charting Your Financial Victory Lane
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After considering a 403(b) loan to cover an expense, you might want to reconsider if you have alternative sources of money, such as a personal loan with a lower interest rate. This is because borrowing from your retirement savings means missing out on potential investment returns.
Another important consideration when contemplating a 403(b) loan is the tax implications. If you're using a pre-tax 403(b) account, the interest you pay yourself is taxable now and again upon withdrawal. However, if your plan offers a designated Roth account, taking a loan withdrawal exclusively from that Roth account can help avoid double taxation.
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