Asking your future self for a loan

Posted by Cindy Wilson.
If you’re rich in retirement savings but cash poor, you may have considered taking a short-term loan on your 403(b)—and then thought better of it.
It may surprise you, then, to discover just how many cash-strapped employees do borrow from their retirement accounts: Among eligible participants, around one in five people have an outstanding loan on their 401(k) plan.1 I would guess that their nonprofit twin sister, the 403(b) loan, is just as popular.
Under certain circumstances, a 403(b) loan can be the lesser of many evils—the worst of which is a premature withdrawal.

403(b) loans vs. early withdrawals

Full disclosure: A couple of decades ago, I relocated for work—and although I had plenty of retirement savings, I didn’t have an established emergency fund. So, I took a $10k distribution from my IRA to use towards the purchase of a condo—which continued to grow in value until it was sold. I would not have borrowed that money to, say, travel the world.
Generally speaking, though, the difference between a loan and a withdrawal is a bit like the difference between visiting your future self to nicely ask if you can borrow ten dollars—and smashing open her cookie jar, without bothering to clean up the mess.
With an early withdrawal, you’ll not only lose the deferred earnings that money could have made, but it will trigger immediate income taxes—including 20% federal withholding as well as possible state taxes—and likely a 10% penalty on top.
With a loan, the understanding is that you will pay it all back, eventually restoring your balance to its original state. The cost to you (as with any loan) is the interest accumulated. You’re also paying an opportunity cost: You’ll lose any potential earnings that the borrowed amount would have made had it stayed inside your 403(b).

403(b) vs. other loans


Let me say straight off the bat: Loans should be avoided—except where they are unavoidable (student loans and mortgages being the best examples). Unfortunately, a sizeable number of borrowers default on their loans, because they overestimate how easy it will be to pay them back, or because they lose their job and need to pay everything back in a hurry.
I would bet that most of that 20% of 401(k) borrowers (numbering the millions) weren’t in desperate need of those 401(k) funds. In my experience, people are using funds from their 403(b) or 401(k) simply to maintain the lifestyle to which they’ve become accustomed—or think they need. Before even thinking about a loan—of any kind—we should consider adjusting our standard of living, or properly redefine “needs” (that new car, kitchen) as wants. And you can’t always get what you want.
However, when that hurricane does come and lay waste to the roof over your head, a 403(b) loan could be your least expensive, most convenient way to come up with the money you need (assuming your employer plan allows for it). In reality, you are borrowing money that is essentially yours to begin with, so it isn’t a loan in the normal sense, but rather a kind of special access pass to a portion of your retirement account on a tax-free basis (generally, no more than 50% of your account balance or $50,000—whichever is the lesser). And on a positive note, the interest rate is typically lower than anything you would find elsewhere, and your credit rating is not a factor when applying.
With most 403(b) plans, there’s a five-year repayment schedule, although in most cases, you can pay the loan back sooner. Check your specific plan rules. Also, you can use a 403(b) for the purchase of a primary residence, in which case you can pay the loan back over a longer period than five years.
Important caveat: If you leave your job while still owing money on your loan, you may be able to repay using the same schedule or you may need to repay it in full, within a grace period of around 60 to 90 days, before you can roll your balance to an IRA or new employer plan. Otherwise, the outstanding balance will be considered taxable, and you may face a 10% early withdrawal penalty. Check the repayment requirements for your specific employer plan.
Bottom line: For more flexibility, the best plan is to have adequate, liquid emergency savings. But as a quick-fix solution, an in-plan loan may work in your favor—as long as you repay it on time, and stay on track with your savings goals.
1 Employee Benefit Research Institute, “Many Have Access to 401(k) Loans, Few Have Outstanding Balances,” https://www.ebri.org/pdf/FF.264.K-loans.16Jan142.pdf, EBRI.org, January 16, 2014
Teachers Insurance and Annuity Association of America has sponsored Ask the Expert posts for informational purposes only. Many of the experts are unaffiliated with Teachers Insurance and Annuity Association of America, College Retirement Equities Fund, and their affiliates and subsidiaries (collectively TIAA), and TIAA makes no representations regarding the accuracy or completeness of any information on the posts or otherwise made available by the experts. Statements of external featured experts are solely their own and are not endorsed or recommended by TIAA.
Responses from experts to questions posed by Woman2Woman community members are intentionally general in nature and are not intended to give personal, financial, or specific advice. Some strategies are complex, and more information is often needed to determine the personal needs of a community member. We strongly recommend that you consult with a financial advisor before taking any action based on an expertʼs opinion or other information you obtain from the Woman2Woman:Financial Living site so that all of your personal circumstances can be taken into consideration. Participation in the site does not render the member a client of the expert or of TIAA.
This site is not designed to accept or respond to requests or complaints regarding specific TIAA accounts, products or services. If you wish to discuss an issue of that nature, please contact TIAA at 800-842-2252. TIAA is not responsible for any opinions provided by members of this site. TIAA is not responsible for the content or privacy policies of third-party sites to which you may link.
The TIAA group of companies does not offer tax or legal advice. You should consult an independent tax or legal advisor for advice based on your own particular circumstances.
The material and responses are for informational or educational purposes only and do not constitute a recommendation or investment advice in connection with a distribution, transfer or rollover, a purchase or sale of securities or other investment property, or the management of securities or other investments, including the development of an investment strategy or retention of an investment manager or advisor. The material and responses do not take into account any specific objectives or circumstances of any particular individual, or suggest any specific course of action. Investment decisions should be made in consultation with an investorʼs personal advisor based on the investorʼs own objectives and circumstances.
Experts may not have medical or scientific training. Any information related to physical or emotional health is not intended to be used in place of a consultation with a physician.
TIAA is not responsible for the statements of community members. We may link to posts made by community members only to direct you to topics that may be of interest to you. This does not mean that we agree with the opinions of these community members. Their statements are solely their own and are not endorsed or recommended by TIAA.
February 26, 2016
419811