A 403(b) loan can be used to purchase a home, but it comes with some risks.
Some 403(b) plans allow you to borrow
A retirement plan loan allows you to borrow from your savings, then repay that amount to the plan over time. There is no tax penalty on this amount if you repay it according to the terms and conditions set by the plan.
So, can you borrow from a 403(b) account to buy a home?
Under the Internal Revenue Code (IRC), loans from 403(b) plans are permitted for employees. However, this does not mean that your plan will offer loans; plan sponsors can decide whether they will do so. If your plan allows 403(b) loans, you may be able to use some of your retirement savings to help purchase a home.
If you are unsure whether your plan allows loans, you can contact the plan sponsor to inquire about borrowing. The plan sponsor may be able to provide you with more details about how these loans work, which can help you decide if borrowing from a 403(b) account is a good option.
Borrowing rules from a 403(b) account
The IRS sets specific rules governing loans from retirement plans, including 401(k) and 403(b) plans. These rules specify the amount of money you can borrow, the timeframe in which you must repay a retirement plan loan, the interest you will pay, and the repayment requirements you must meet to avoid tax penalties.
How much can you borrow from a 403(b) account?
The amount you can borrow from a 403(b) plan is calculated using one of two methods. According to IRS rules, the maximum amount that the plan can allow as a loan is:
- The greater of $10,000 or 50% of your vested account balance
- Or $50,000, whichever is less
So, in simple terms, the maximum amount you can borrow from a 403(b) plan to buy a home is $50,000. The actual limit will depend on how much you have in the plan and how much of that is vested.
How long do you have to repay a 403(b) loan?
The IRS allows borrowers five years to repay a retirement plan loan, including 403(b) loans. Repayment must be made in equal installments that include both principal on the loan and interest.
There is an exception for 403(b) loans used to purchase a primary residence. If you are borrowing from a 403(b) to buy a home, the IRS allows plan sponsors to grant a longer repayment period. For example, you may have up to 15 years to repay it.
Do you pay interest on a 403(b) loan?
The IRS requires that interest be charged to borrowers on loans from retirement plans. The Internal Revenue Code does not specify whether plan sponsors can charge excessive interest rates, but it states that “the interest rate and repayment schedule must be comparable to what the participant can expect from a financial institution.”
The plan sponsor should be able to provide you with more details about the interest rate you will pay on a 403(b) loan. You should also keep in mind that if you default on a 403(b) loan, interest can continue to accrue until you bring the loan to a current status.
Can you pay off a 403(b) loan early?
If you can make extra payments toward the balance, it is possible to pay off a 403(b) loan ahead of schedule. This can save you money on interest charges over the life of the loan. It is up to the plan sponsor to determine if this is allowed.
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 amount due becomes due in full. If you are unable to repay the outstanding amount on the loan, the plan sponsor may treat the entire amount as a taxable distribution and report it to the IRS on Form 1099-R. This means you will owe income tax on the distribution, along with any applicable tax penalties.
Advantages
Disadvantages of Using Your 403(b) Savings to Buy a Home
Advantages
- No credit check required: Unlike personal loans or other loans, a 403(b) does not require a credit check for loan approval. This type of debt also does not appear on credit reports, so there is no impact on your credit score.
- Low-interest rates: The IRS prohibits plan sponsors from charging exorbitant interest rates on 403(b) loans. You may also have a longer repayment period for a retirement plan loan compared to a personal loan.
- Paying yourself back, not the lender: When you pay back a 403(b) loan, you are paying interest to yourself instead of to a lender. As long as you repay the loan on time, there are no tax penalties.
Disadvantages
- Lost retirement savings growth: Borrowing from a 403(b) means that money does not have the chance to grow through the power of compound interest. This amount may be less than the money you would have saved when you are ready to retire.
- Double taxation: Contributions to a 403(b) are made on a pre-tax basis, and then you pay taxes on withdrawals in retirement. However, when you pay back a loan from your plan, you are repaying it with after-tax dollars, which ultimately means you will be taxed twice.
- Defaulting can lead to tax consequences: If you default on a 403(b) loan or leave your job before the loan is fully repaid, you may be left with a significant tax bill. Again, you will owe regular income tax on the distribution, but depending on your age, you may also owe an early withdrawal penalty.
How to Borrow from a 403(b) Account
If you want to apply for a 403(b) loan, you can contact your plan sponsor to find out how to proceed. Your employer may require you to complete a loan application online. Generally, you will need to specify:
- What you plan to use the money for
- How much you want to borrow
Once you submit a loan application to your employer, you will also need to complete a separate request to withdraw funds from the brokerage firm that manages your 403(b) plan. There may be an application fee to do this.
If your loan is approved, the amount may be deposited into a separate account with the brokerage firm. You may also be able to transfer the funds to your bank account or receive it in the form of a paper check. You can arrange for repayment via automatic payroll deductions with the plan sponsor.
Should You Use Your 403(b) Savings to Buy a Home?
Using your 403(b) savings to buy a home can be suitable if you don’t have enough cash for a down payment and want to be able to borrow up to $50,000 at a low interest rate. However, before proceeding with this decision, it is helpful to consider the long-term impact on your retirement savings, as well as other options you may have for financing your home purchase.
Frequently Asked Questions (FAQs)
How do I repay the money I borrowed from my 403(b) account?
You can repay a 403(b) loan through payroll deductions. It must be
Source: https://www.thebalancemoney.com/can-you-borrow-from-your-403-b-to-buy-a-house-5271287
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