Your 401(k) or 403(b) retirement account is probably one of your largest assets. If you need to access extra funds, you may wonder, “Can you borrow from your 403(b)?”
In many cases, you can. Here’s a closer look.
Understanding 403(b) Retirement Plans
Most people have heard of 401(k) retirement plans. These plans are offered to employees at many companies in the private sector.
If you work for a public school or a tax-exempt organization, you may have a different retirement plan option: the 403(b). Although the name is different, a 403(b) works similarly to a 401(k), and the plans have identical yearly contribution limits.
For What Reasons Can You Withdraw Money From a 403(b)?
It helps to know when you can take money out of your account, whether you’re hoping to borrow from a 403(b) to pay off debt or want to permanently withdraw funds. These are some of the main reasons for withdrawing funds:
- You reach retirement age
- You encounter financial hardship
- You leave or lose your job
- You become totally and permanently disabled
- You need to take out a loan from the account to pay for a large expense
The IRS states that employers may allow employees to take out loans from their 403(b) retirement accounts. This is not a requirement, however. So, while some companies offer this option, others do not.
If you’re considering borrowing from your 403(b), start by asking your plan administrator if your plan allows loans.
How Does Borrowing From Your 403(b) Work?
Many people are drawn to 403(b) loans because there’s no credit check, and because interest rates tend to be lower than those on some bank loans.
What are the rules for borrowing funds from a 403(b)? While each plan has slightly different rules, these are some common terms:
- You must repay the loan within five years
- If the loan was for a primary residence, the repayment period can be up to 15 years
- You must make payments at least quarterly
- You may have to immediately repay the loan if you leave your job
Not everyone has the means to repay a loan balance if they leave their employer. If you are unable to pay your loan back in full, the balance will be treated like a distribution from your account. That means you’ll likely owe both income tax and a 10% early distribution penalty.
You might also ask, “How much money can I borrow from my 403(b)?” The IRS limits the amount you may borrow to the lesser of these two numbers:
- 50% of your vested balance
- $50,000
However, your employer may impose different restrictions on how much you can borrow. Individual plans have a lot of freedom to set their own loan terms, so make sure you understand these terms before you commit.
When Can You Borrow From Your 403(b)?
Individual plans can set their own rules for when you can borrow from a 403(b) account. This means that your plan may limit when and why you can borrow money from your 403(b).
Your 403(b) documents should clearly outline the terms of your retirement plan, including any restrictions on loans. If the document isn’t clear or you want some extra guidance, your plan administrator should be able to help.
What Are the Pros and Cons of Borrowing From a 403(b)?
Borrowing from your 403(b) may seem less complicated than taking out a bank loan. However, it’s still a major financial decision, and it’s important to consider the pros and cons first.
These are some advantages of borrowing from your 403(b):
- Interest rates are usually lower than for personal loans
- Unlike with distributions, you don’t have to pay a 10% withdrawal penalty
- Getting approved is typically fast and easy
There’s a lot to like about 403(b) loans, but you should also be mindful of their disadvantages:
- Loan funds are no longer invested, so you could lose out on returns
- If you default, you could owe both a 10% penalty and income tax
- Losing your job means you may have to repay the balance immediately
There is also a substantial tax disadvantage to consider. Your 403(b) contributions are made with pre-tax dollars. When you repay a 403(b) loan, however, you do so with post-tax dollars.
When you retire, your distributions will be treated as income. This means that you effectively pay taxes twice on the money you repay to your 403(b).
Is a 403(b) Loan Right for You?
Can you borrow from your 403(b)? Yes, probably. But should you?
The answer depends on both the specifics of your plan and your long-term goals. While 403(b) loans have been helpful to many, they’re far from your only option. It may help to look at other options first.
Credit counseling, debt consolidation, and debt settlement are three common ways to manage or reduce what you owe without putting your retirement savings at risk.
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