A 403(b) plan is a tax-advantaged retirement plan that's designed for certain public or nonprofit private school employees, people who work for other types of tax-exempt organizations, and ministers. Also known as a tax-sheltered annuity, a 403(b) plan generally doesn't allow for early withdrawals but your plan might allow you to take out a loan against your savings.
For example, you might use a 403(b) loan for a major purchase like a home. Before you do so, however, it's important to understand how that can affect your savings for retirement and the potential tax implications.
- A 403(b) plan is a tax-advantaged retirement plan available to certain employees, including people who work for public schools, employees of tax-exempt organizations, and ministers.
- Early withdrawals from a 403(b) plan are generally not allowed, though plans can allow 403(b) loans.
- Borrowing from a 403(b) account may be an option if you'd like to buy a home and don't have enough cash for a down payment.
- If you leave your employer, any remaining 403(b) loan balance becomes payable immediately.
Some 403(b) Plans Allow You To Borrow
A retirement plan loan allows you to borrow against your savings, then pay that money back to the plan over time. The IRS does not assess tax penalties against this money if you repay it according to the terms and requirements set up by the plan.
So, can you borrow from your 403(b) plan to buy a house?
Under the Internal Revenue Code (IRC), 403(b) plans are permitted to offer loans to employees. That doesn't mean, however, that your plan will offer loans; plan sponsors can decide whether to do so. If your plan does permit 403(b) loans, you may be able to use some of your retirement funds to help buy a home.
If you're unsure whether your plan allows for loans, you can contact your plan sponsor to ask about borrowing. Your plan sponsor may be able to provide you with more details on how such loans work, which can help you decide if borrowing from your 403(b) is a good option.
If you're married and your spouse is the beneficiary of your 403(b) account, your plan sponsor may require their consent before granting a loan.
Rules for Borrowing From a 403(b)
The IRS has specific rules governing loans from retirement plans, including 401(k) plans and 403(b) plans. These rules govern how much you can borrow, how long you have to repay a retirement plan loan, what you'll pay in interest, and repayment requirements you'll need to meet to avoid a tax penalty.
How Much Can You Borrow From Your 403(b)?
The amount you can borrow from a 403(b) plan is calculated in one of two ways. Under IRS rules, the maximum amount that the plan can permit as a loan is:
- The greater of $10,000 or 50% of your vested account balance
- Or $50,000, whichever is less
So, in a nutshell, the most you can borrow from a 403(b) plan to buy a home is $50,000. Your actual limit will depend on how much you have in your plan and how much of that is vested.
You can have more than one retirement plan loan at a time, but the total balances cannot exceed $50,000.
How Long Do You Have To Repay a 403(b) Loan?
The IRS gives borrowers five years to repay a retirement plan loan, including 403(b) loans. Payments must be made in substantially equal payments that include both principal on the loan and interest.
There's an exception for 403(b) loans that are used to buy a principal residence. If you're borrowing from your 403(b) to buy a home, the IRS allows plan sponsors to grant a longer repayment period. For example, you might have up to 15 years to pay it back.
Do You Pay Interest on a 403(b) Loan?
The IRS requires that retirement plan loans charge interest to borrowers. The Internal Revenue Code doesn't specify what rate plan sponsors can charge, but it does state that "the interest rate and repayment schedule should be similar to what a participant might expect to receive from a financial institution."
Your plan sponsor should be able to give you more details on the interest rate you'll pay for a 403(b) loan. Also, keep in mind that if you default on a 403(b) loan, interest can continue to accrue until you bring the loan current.
Can You Repay a 403(b) Loan Early?
If you're able to make extra payments toward the balance, it's possible to pay off a 403(b) loan ahead of schedule. Doing so could save you money on interest charges over the life of the loan. Whether your plan allows this will be up to the discretion of the plan sponsor.
What Happens to a 403(b) Loan if You Leave Your Job?
Leaving a job with a 403(b) balance can be problematic, as the remaining balance due becomes payable at once. If you're unable to pay off what's owed on the loan, your plan sponsor can treat the entire amount as a taxable distribution and report it to the IRS on Form 1099-R. This means you'd owe income tax on the distribution, along with any applicable tax penalties.
You can avoid the tax consequences associated with leaving employment while you have a 403(b) loan by rolling over the outstanding balance to an individual retirement account (IRA) or another eligible retirement plan.
Pros and Cons of Using Your 403(b) To Buy a House
No credit check required
Low interest rates
Pay yourself back, not a lender
Missed retirement savings growth
Failure to repay can trigger tax consequences
No credit check required: Unlike personal loans or other loans, a 403(b) doesn't require a credit check for approval. This type of debt doesn't show up on credit reports either, so there's no impact on your credit score.
Low interest rates: The IRS prohibits plan sponsors from charging exorbitant interest rates for 403(b) loans. You also may have more time to repay a retirement plan loan than you would a personal loan.
Pay yourself back, not a lender: When you repay a 403(b) loan, you're paying interest back to yourself, rather than to a lender. As long as you pay the loan back on schedule, there are no tax penalties.
- Missed retirement savings growth: Borrowing money from a 403(b) means those funds do not have an opportunity to grow through the power of compounding interest. This could lessen the amount of money you have saved once you're ready to retire.
- Double taxation: Contributions to a 403(b) are made on a pretax basis, then you pay taxes on withdrawals in retirement. But when you take out a loan from your plan, you're repaying it with after-tax dollars, which essentially means you eventually will be paying the tax twice.
- Failure to repay can trigger tax consequences: Defaulting on a 403(b) loan or leaving your job before the loan is paid in full could leave you with a sizable tax bill. Again, you'll owe regular income tax on the distribution but, depending on your age, you also may owe an early withdrawal penalty.
How To Borrow From Your 403(b)
If you'd like to apply for a 403(b) loan, you can contact your plan sponsor to find out how to do so. Your employer may require you to complete a loan application online. Generally, you'll need to specify:
- What you plan to use the money for
- How much you want to borrow
Once you've submitted a loan application to your employer, you'll also need to complete a separate application to request funds from the brokerage firm that manages your 403(b) plan. There may be an application fee to do so.
If your loan is approved, the money may be deposited in a separate account with the brokerage. You also may be able to transfer the funds to your bank account or receive them as a paper check. You can arrange for repayment via automatic payroll deductions with your plan sponsor.
Should You Use Your 403(b) Savings To Buy a House?
Using your 403(b) savings to buy a house could make sense if you don't have sufficient cash for a down payment and you want to be able to borrow up to $50,000 at a low interest rate. Before moving ahead with this decision, however, it's helpful to consider the long-term impact to your retirement savings as well as other options you might have for funding a home purchase.
Frequently Asked Questions (FAQs)
How do I pay back the money I’ve borrowed from my 403(b)?
You can make repayments for a 403(b) loan through paycheck deferrals. Payments must be made at least quarterly, under IRS rules. Loan repayments are not considered contributions to your plan, which you can make separately.
Does borrowing from your 403(b) affect your credit score?
Borrowing from a 403(b) plan should not affect your credit score, as there's no credit check required and these loans are not reported to credit bureaus.
Can I borrow from my 403(b) if I no longer work for the company?
The IRS allows 403(b) plan loans to current employees. If you're no longer employed with the company that holds your 403(b), you may be able to take a distribution of the money in the plan. But it would be considered a taxable withdrawal, not a loan.
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