Your district’s 403(b) and/or 457 plan offers a convenient and tax-advantaged way to build a retirement nest egg. Voluntarily saving to supplement your CalSTRS or CalPERS pension can help you maintain your lifestyle once you no longer receive a regular paycheck. But there’s a catch (isn’t there always a catch?): Since the money is intended to pay for retirement, there are restrictions on withdrawing it early.
Usually, that’s not a problem. But sometimes, life throws you a curve ball, and you may suddenly wish you had access to the money you’ve been tucking away for your golden years. Some districts’ 403(b) and 457 plans have loan provisions that allow you to borrow from the balance accumulated in your account. If loans are offered, they are generally limited to 50% of your account balance or a maximum of $50,000 – whichever is less – and generally must be repaid with interest within five years. Individual vendors may apply additional conditions for loans.
If your district’s plan allows loans, it may seem like an easy answer to whatever financial situation you’re facing. But before you take a loan, it’s important to consider all the potential costs and ramifications of doing so. They’re not always obvious, so be sure to take a close look. The calculator What Will It Cost to Borrow from My 403(b) or 457 Plan? at CTAinvest.org can help you understand the impact of a loan on your retirement nest egg.
Weigh the Pros and Cons
There may be both advantages and drawbacks to borrowing from your 403(b) or 457 plan.
In the plus column, no credit check is involved, and you do not need to meet the lending requirements of a bank, credit union or other financial institution. In many cases, the interest rate is competitive and may be paid back into your own account. (Caution: Be sure to ask about this. In some cases, only the principal is repaid to your account, and the interest you pay goes to the vendor instead of to you.)
In the negative column, the fees you must pay to take a loan from your 403(b) or 457 plan, in addition to the interest, may make this a more expensive option than borrowing from your bank or credit union.
You’ll have to repay the loan with after-tax dollars, even though the money you borrow went into your account pre-tax. Then, when you withdraw the money from your account in retirement, you’ll pay taxes on that same money again.
Also, if you lose your job, you’ll have to repay the loan immediately or it will be considered a distribution, subject to ordinary income tax. If the loan is from a 403(b) plan and you’re younger than age 55, you may owe a 10% tax penalty under these circumstances, too. (There is no penalty on 457 plan distributions.)
Perhaps worst of all, you will lose the potential for tax-deferred compounding on the money, had it stayed in your account. And, depending on the rules of your plan, you may not be allowed to make additional contributions to your plan until the loan is repaid. The result could be that you imperil your financial security in retirement. That’s a mighty high cost for a loan. Consider carefully.