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Meadow6

403b Withdraw

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Due to the lack of growth in my 403B and also interest in using money to buy a new house or pay off credit card debt: I was wondering if it is possible to cash in a 403B?

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Guest Sierra

It sure is if you satisfy one of the following triggering events:

 

1. Attainment of age 59.5

2. Disability

3. Separation from service

4. Death

5. Financial hardship.

 

Peace and Hope,

Joel L. Frank

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Failing the attainment of any of those "triggering events," many 403B plans also have loan provisions...you can borrow some part of the balance of your account (usually up to 50%) for any reason you choose.

 

The penalties and taxes for a premature withdrawal are tough to swallow, though...I wouldn't recommend them except as a last resort.

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Guest Sierra

Do not borrow from a pre-tax account like a 403(b) because your investment balance is reduced by the amount of the loan. Additionally, the loan repayment amount is paid with after tax dollars and when subsequently withdrawn during retirement is taxed again. Even if all loans are paid back, at retirement your account balance is less than it otherwise would be!

 

Principle: DO NOT BORROW FROM A TAX DEFERRED ACCOUNT.

 

Peace and Hope,

Joel L. Frank

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Joel hits it right again. Agents often tout the benefit of borrowing from a 403b account, but doing so results in double taxation: you are taxed on the money that you pay back to the account, and since that was so much fun, you get taxed again when you withdraw the money during retirement.

 

This is, once again, a problem that people have as a result of dealing with unscrupulous agents who do not provide full disclosure.

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Guest Sierra

and it must be EMPHASIZED!!!!!...THAT THE FINAL ACCOUNT BALANCE CAN BE THOUSANDS OF DOLLARS LESS THAN IT OTHERWISE WOULD BE DEPENDING ON THE AMOUNT AND FREQUENCY OF TAKING OUT THESE KINDS OF LOANS.

 

Peace,

Joel

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Doesn't it depend on a few different variables, including the rate of interest charged and the performance of the market during the time the loan in question is outstanding?

 

Example: let's say your 403(b) has a "net zero" loan available, whereby the interest that is charged on your loan (let's say 6%) is credited back to your account as interest as you pay it back. Hence a "net" rate of zero percent. During the time your loan is outstanding (let's say three years), the market is flat, or declines slightly. Seems to me the borrower might potentially make out on the deal, especially if the money in question is used to build a new room on the house (thereby increasing the value of one's real estate), or something to that effect.

 

In general, of course, I agree that loans from 403(b)'s are detrimental to one's long-term savings, especially if used frivolously or too frequently. But as with all things, circumstances sometimes dictate otherwise.

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Guest Sierra

If you want to improve the house you live in, take a home equity loan where the interest is tax-deductible and you are borrowing someone else's money not your own. If your current cash flow can't support the monthly payments then reduce your 403(b) contribution or cut it out entirely.

 

Peace and Hope to the French Teacher From Joel L. Frank

 

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Sierra and Westerndad are right about not taking loans if you don't need to, but the tax argument is completely bogus.

 

When you borrow from a 403(b) account, you are paid out in after-tax dollars. When you repay the loan, you repay it in after-tax dollars. The loan is a non-tax event on both ends. You can torture the logic by calling it double-taxed by just looking at the loan repayment and the future withdrawal, but if you do that, then to be fair you have to count the initial loan as never-taxed, since you contributed pre-tax dollars and borrowed after-tax dollars. It's better to skip all that and treat the loan as the non-tax event that it really is.

 

The non-fictional problems with the loan are three-fold:

 

#1, most vendors will credit your loan as an investment, but at a lower rate than you pay for the interest. So you pay, say, 6% and your account only gets credited for, say, 5%. But that isn't too bad. Your net cost is only 1% (typically -- but vendors differ).

 

#2, the bigger potential cost is opportunity cost. If you borrow against your 403(b) and the market soars, you lost out on a big opportunity to make a tax-deferred killing. On the other hand, if you borrow and then a bear market hits, you look like a genius.

 

#3, there is also a risk of getting penalized if, for some reason, you cannot repay the loan. Say you lose your job: you'll need to repay your loan in cash. If you don't have the cash and you default on the loan, the IRS will consider the unpaid portion to be a taxable distribution, and if you are under age 59-1/2 you will get hit with the 10% penalty for early withdrawal. So don't borrow more than you are sure you can repay under that scenario.

 

Having said all that: borrowing from the plan is not really such a bad thing, and if you don't have other handy resources, it can be a pretty decent choice. I used to borrow from a 401(k) plan I had when I was younger back in the days when my then employer would allow us to do so to buy new cars -- it worked fine!

 

--Chuck

 

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Guest Sierra

When you borrow from a 403(b) account, you are paid out in after-tax dollars. When you repay the loan, you repay it in after-tax dollars. The loan is a non-tax event on both ends.

+++++++++++++++++++++++++++++++++++++++++++

 

Chuck:

 

Assume a $50,000 balance and I borrow (withdraw) $30,000 . The $30,000 is not taxable to me because it is a loan. It is just like borrowing $30,000 from the bank. But the repayment amount is with after tax dollars. So let's say you are in the 25 percent bracket (fed, state, local). You must earn $40,000 in order to payoff the $30,000 loan. Let's say it takes 5 years to payoff the loan and bring the account back to $50,000. So at the end of the five year period the new car that you bought needs to be replaced and the account balance has been fully replenished so you have the same $50,000 that you had five earlier. Assuming one does this every 5 years to buy a car or 6 times during a career of 30 years he/she winds up with thousands of dollars less in the account at age 60 when he she is ready to retire.

 

Here is the rub. You put in pre-tax dollars and borrowed pre-tax dollars and paid back with after tax dollars. All of the loan payments that were made with after tax dollars are now in a pre-tax account subject to taxation when withdrawn during retirement. If one is constantly borrowing from his pre-tax account he/she winds up primarily funding the account with after tax dollars with future withdrawals not made in the form of a loan subject to tax.

 

Peace and Hope,

Joel

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Chuck,

 

With all due respect, the double taxation argument is in fact valid. Joel has it correct:

 

--------------------------------------------------------------------------------------------------

 

Here is the rub. You put in pre-tax dollars and borrowed pre-tax dollars and paid back with after tax dollars. All of the loan payments that were made with after tax dollars are now in a pre-tax account subject to taxation when withdrawn during retirement.

 

---------------------------------------------------------------------------------------------------

 

 

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AND...

 

If for some reason you default on the loan, many insurance companies continue to charge interest on your un-paid balance even though you defauted and paid the taxes and penalties! Further reducing your account when you finally close your account.

 

I know this sounds crazy but its true. I will look up the exact details and post them here tomorrow.

 

JM

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Double Taxation,

 

Chuck is more right than wrong here, though I was a bit confused by his answer, it is pretty right on. You are double taxed on loans, but generally only to the extent of the interest you pay. The money coming out of the plan as a loan to you has never been taxed and you don't pay tax on the proceeds (unless you default), but you do pay interest on the loan into the plan and that interest is money that has already been taxed, thus the loan payment is not double taxed (yes, you are paying back with after-tax funds, but you recieved pre-tax funds - so they balance out), but the interest payment is double taxed. Typically the interest is not a significant portion of your account balance, thus it isn't going to be that bad.

 

I am not a fan of loans, but believe they have some utility if used and disclosed properly - having said that, most people don't use loans in a wise fashion.

 

ScottyD

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Scotty,

 

I may be wrong, so feel to correct me on double taxation:

 

1st taxation: on money that is used to repay the loan.

 

2nd taxation: on money that is withdrawn during retirement.

 

You mentioned that money coming out of the account has never been taxed, and that is certainly correct. But WHEN IT IS WITHDRAWN (#2 above), it is taxed. Couple that with #1 above, and don't you have double taxation?

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WesternDad, it is complicated because you do use after-tax funds to pay it back, but your original deduction never went away.

 

I'll try to use an example:

 

You contribute $1,000 pre-tax, saving $250 in federal taxes. Then you borrow that $1,000 without paying any tax on it, you spend it on whatever you spend it on. When you pay that $1,000 back you are paying back the pre-tax amount that you spent, your simply replacing the money. If you were forced to pay the taxes with you took the loan and then paid the loan back, they you would have full double taxation. As it stands the $1,000 is simply being replaced and the interest is added to the account, which is double taxed as you never recieved a deduction for the interest.......clear as mud?

 

Don't get me wrong, I am not defending the loans....just making sure they are put in proper context.

 

ScottyD

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