Think twice before you turn to your UC 403(b) Plan account for cash.
Taking a loan from your UC 403(b) Plan account to deal with an unexpected financial need seems like a simple solution, doesn’t it? The 403(b) Plan does allow you to borrow from your account. And it is your money, after all. But the decision to tap your account isn’t so simple when you consider the consequences.
1. Your loan payments come out of your paycheck.
You’ll tie yourself up for automatic payments over the life of your loans—up to five years if it is a general loan, up to 15 if you are using it to buy a house. Make sure you can afford the extra payments coming out of your paycheck.
2. You’ll pay taxes twice.
You’ll pay back your loans with after-tax dollars, even if you made the original contribution before taxes. So your loan repayment won’t work the way your contributions work—a $100 loan repayment will reduce your take-home pay by $100. Worse, when you take the money out of your 403(b) Plan during retirement, you will pay tax on the same money again, because when the money is back in the plan, it’s still considered a pre-tax contribution.
3.You lose out on potential investment growth.
When you borrow money, you pay yourself interest. The interest rate on your loan will be whatever the prime rate is plus 1%. Interest rates right now are at historic lows so, if you took a loan as of January 1, 2016, you would pay yourself 4.5% interest. 1
Now, as a consumer, a low interest rate is good. But as an investor, you’re giving up potentially much higher returns you could have received if you had kept the money invested. How much higher? While past performance doesn’t guarantee future returns, it’s interesting to note that, between 1965 and 2014, the average annual return was 9.9% for domestic stocks and 7.0% for bonds. 2
4.You pay fees for taking a loan.
You’ll pay an initial setup fee of $35 and a $15 annual fee. If the loan is for a home, the fees may be lower than typical mortgage costs. But you won’t be able to refinance if rates drop, and you can’t take an interest deduction on your income taxes.
5. You must pay back the outstanding balance in full or pay taxes on the amount you don’t repay.
If you leave UC and do not repay your loan, the amount you do not repay is considered a distribution. That means you will have to pay federal income tax on that amount and, if you’re younger than age 59½, a 10% early withdrawal penalty.
Weigh the consequences on your future financial security before you tap your UC 403(b) Plan account. If you can do without or find money elsewhere, keep your 403(b) Plan account intact. Finally, if you can't avoid borrowing from your account, try to repay your loan early.
1 "Wall Street Journal Prime Rate," Bankrate.com, January 1, 2016.
2 Data Source: Ibbotson Associates, 2015 (1965–2014). Past performance is no guarantee of future results. The asset class (index) returns reflect the reinvestment of dividends and other earnings. The data shown is for illustrative purposes only and does not represent actual or future performance of any investment option. It is not possible to invest directly in a market index. Stocks are represented by the Standard and Poor’s 500 Index (S&P 500® Index). The S&P 500® Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. Bonds are represented by the U.S. Intermediate Government Bond Index, which is an unmanaged index that includes the reinvestment of interest income. Short-term instruments are represented by U.S. Treasury bills, which are backed by the full faith and credit of the U.S. government. Stock prices are more volatile than those of other securities. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks but provide lower potential long-term returns. U.S. Treasury bills maintain a stable value (if held to maturity), but returns are only slightly above the inflation rate.