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403(b) Loans ... Do Or A Don't?


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#1 TXTeach

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Posted 10 September 2006 - 09:45 PM

Need some help here. Trying to decide if a 403(b) plan with the availability to borrow money from the plan is a good idea. Sounds like I can pay off some debt before retirement. How smart of an idea is it to borrow against this type of plan?? Does anyone have experience with this or any recommendations? Thanks for the info!

#2 sschullo

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Posted 10 September 2006 - 11:08 PM

Hi TXTeach,
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.
Steve

#3 ira

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Posted 10 September 2006 - 11:38 PM

Additionally, o want to keep money in your 403b or IRA as long as possible, since there there is a tax free advantage, even while retired. Your retirement can last 30 years or more. The money will be worth more to you if keep it in the retirement vehicle


#4 Guest_Sierra_*

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Posted 11 September 2006 - 09:23 AM

It is a BAD idea to "borrow" 403b monies because the "loan" is nothing more than a tax-free distribution. The investment balance is reduced by the amount of the loan. Even if you pay back the loan(s) the resulting balance is LESS than it otherwise would be because the investment balance was never at FULL STRENGTH.

Peace and hope,
Joel L. Frank

#5 Yanikoski

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Posted 11 September 2006 - 02:25 PM

Although I basically agree with the others, it depends on the situation. If, for example, you have large credit card balances on which you are paying, say, 18% interest, you are better off consolidating that debt into one loan with a lower interest rate and a fixed repayment schedule. In theory, a loan against your retirement plan could be used this way, and that would probably be better than doing nothing at all. But you are probably even better off doing this through your local bank rather than through your retirement plan.

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.


#6 danrobertson

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Posted 12 September 2006 - 06:18 PM

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



#7 Guest_Sierra_*

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Posted 13 September 2006 - 07:19 AM

QUOTE(danrobertson @ Sep 12 2006, 07:18 PM) View Post

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


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,
Joel


#8 Yanikoski

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Posted 14 September 2006 - 03:41 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.

#9 Guest_Sierra_*

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Posted 14 September 2006 - 07:41 PM

QUOTE(Yanikoski @ Sep 14 2006, 04:41 PM) View Post

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.

Chuck,

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.

Joel

#10 JMacDonald

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Posted 14 September 2006 - 09:38 PM

Hi,
Here is an article abouts 403b loans: http://www.403bwise....03bloan_wc.html

Best Wishes,
Joe

#11 Yanikoski

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Posted 15 September 2006 - 02:46 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.

#12 Guest_Sierra_*

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Posted 15 September 2006 - 03:45 PM

QUOTE(Yanikoski @ Sep 15 2006, 03:46 PM) View Post

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.


Chuck,

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?

Joel

#13 kmr16442

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Posted 16 September 2006 - 10:18 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.

#14 Guest_Sierra_*

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Posted 16 September 2006 - 10:49 AM

QUOTE(kmr16442 @ Sep 16 2006, 11:18 AM) View Post

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,
Joel


#15 Yanikoski

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Posted 18 September 2006 - 03:00 PM

How the loan is handled with regard to the product should be spelled out in the product contract, and it probably differes from one provider to another. In general, though, the loan made from the plan to the participant is considered to be a special category of asset within the plan. From the plan's point of view, the outstanding loan earns a rate of interest defined in the plan document or product contract. Therefore it is not available for allocation to other investment options that the plan/product otherwise provides. In a fixed annuity, this might not be an issue. If the annuity pays a fixed rate of, say, 5%, the same 5% could be credited to loaned amounts, while the participant pays a rate of maybe 6% or so. (By the way, this 1% spread can be a lot higher, depending on the vendor, so it is important to know the deal that applies in any given case.) I am not sure how the financial companies do their accounting, but for practical purposes, it is probably best to think of the loan as being against the participant's own plan assets, rather than against the general assets of the provider, regardless of what the product is -- and to think of the loan as an asset apart from the other plan assets.

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.