403(b) Loans ... Do Or A Don't?
Posted 10 September 2006 - 09:45 PM
Posted 10 September 2006 - 11:08 PM
You asked for an opinion from somebody who has done this...Well don't do it. You did not report how much and that is critical. Assuming that is a large debt, IMO its not a smart idea, its just an idea. Whether you pay it off with 403b money or by working a little longer I think depends on what you want to do. Not sure what your rationale is by retiring before this money is paid off. If you use 403b money, you still have the debt in retirement, not a good way to start. The bottom line is that money has to be paid off one way or another. 403b money is for retirement, not used as leverage to paying off a debt.
Author and Co-Author of two books:
1. Late Bloomer Millionaires: A Financial Story and Investment Guide for the Late Starter (2013)
2. Fighting Powerful Interests: Educators Challenge Tax-sheltered Annuities and WIN! (2015)
Posted 10 September 2006 - 11:38 PM
Posted 11 September 2006 - 09:23 AM
Peace and hope,
Joel L. Frank
Posted 11 September 2006 - 02:25 PM
Besides, unless your plan administrator is pretty lax, you probably can't get a plan loan for this purpose anyway. Usually, the plan sponsor and/or product provider specifies the reasons for which a loan is permitted, and paying off other debts is not likely to be one of them.
Posted 12 September 2006 - 06:18 PM
Posted 13 September 2006 - 07:19 AM
It has to be paid back..even though you are borrowing from yourself, you are getting money that was not taxed YET, because it is supposed to be taken out after you retire. But if you take it early you will pay it back with money from income that has been taxed or will be taxed. So you are paying a tax on the money you repay to your account, and will pay taxes on that same payment money again, when you take it out after you retire. Is it worth it? I doubt it...Best of Fortunes, Dan
The loan is made with pre-tax dollars and is paid back with after tax dollars. This represents a wash. The money is then taxed when withdrawn as a normal distribution. The loan amount is not taxed twice.
It is this withdrawal of pre-tax dollars in the form of a "loan" that is most hurtful to the saver of pre-tax dollars. The "loan" amount is no longer subject to investment gains or losses and even if paid back the account balance at retirement is less than it otherwise would be. If one wants to borrow...borrow someone elses money not your own.
Peace and Hope,
Posted 14 September 2006 - 03:41 PM
Posted 14 September 2006 - 07:41 PM
Just to further clarify: loans against 403(b) plans do not participate in investment performance, but they do earn interest. Typically, they earn about 1 percentage point less than the interest you pay. So you pay, say, 7% with one hand, and you receive 6% with the other (403(b)) hand. That's a pretty inexpensive way to finance something. But if your investment funds are doing well, you miss out on that performance while you are getting your fixed return; of course, if you investment funds are not doing well, you could actually come out ahead. That's a crapshoot, though, at best.
Assume the following: $50,000 balance in a fixed account at 6%. You borrow $20,000 at 7 percent.
Q.: Are you saying the amount withdrawn, $20,000, continues to grow at a fixed interest rate of 6 percent just as if it was not withdrawn? Please clarify.
Posted 15 September 2006 - 02:46 PM
Posted 15 September 2006 - 03:45 PM
Joel, yes, that's what I'm saying -- though of course the percentage varies with the vendor. The loan to the participant is an asset of the plan, and the plan receives interest, just as if it were any other commercial entity making a loan. As I mentioned before, usually the interest credited to the account is about 1% less than the interest paid by the member, the difference covering administrative costs (and perhaps some profit). If the product vendor kept the entire 7% interest, that would be a total rip-off. As it is, it's not such a bad deal, depending, of course, on how well the investments are doing where the loaned amount would otherwise be allocated. Still, I agree with your general notion that such loans are usually better avoided if alternative financing is available for one's needs.
So are you saying that if one takes a loan from a variable annuity or mutual fund account the amount of the loan comes directly from the individual's investment account but if one takes a loan from a fixed annuity the amount of the loan comes from the invested assets of the insurance company and the individual's fixed annuity account is not touched? If I am correct in my understanding of your assertion please tell me why the variable annuity or mutual fund cannot handle loans in the same way and keep the individual's account fully invested rather than seeing it reduced by the amount of the loan?
Posted 16 September 2006 - 10:18 AM
Posted 16 September 2006 - 10:49 AM
Another thing to be careful of is what happens if you lose your job for any reason. Typically you have to pay the loan back very quickly, sometimes within a month or so. If you can't pay the money back right away the IRS treats it like an early distribution and sends you a tax bill that includes a nice 10% penalty for early withdrawl. You don't have to worry about this scenario with a regular bank loan.
You are correct. But according to Chuck this does not apply to 403b fixed annuity interest rate holders because they borrow money from the insurance company and not from their individual account balances. Let's hear from Chuck.
Peace and hope,
Posted 18 September 2006 - 03:00 PM
As for what happens if someone terminates employment while with an outstanding loan, I don't think that this is defined by the tax code or regulations, so it probably varies from vendor to vendor. I am not an expert on this subject, but I am not aware of any reason why a loan could not continue past termination. A plan with a loan can even be transferred to another vendor, if all parties agree to it. However, while someone is employed, loan payments would normally be taken out of that person's pay, so missing a payment is not a problem. When someone is no longer employed, payments would have to made in some other way. The law is pretty strict about missed payments triggering defaults, where a default is interpreted as a withdrawal, which then is subject to taxation and possibly penalty taxes. None of this is good for anybody, so if some vendors have rules about loans being repaid at termination of employment, that could be why.