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. But the decision to tap your account isn’t so simple when you consider some of the consequences.
Employees often reduce or stop saving in their retirement savings plan after taking out a loan, which can significantly hinder their savings abilities.
However, life is unpredictable. Sometimes we have to choose: take a 403(b) loan or another kind of loan. So, if you’re considering a 403(b) loan, here’s what you need to know:
You can take either a home loan or a general purpose loan. General loans must be repaid within five years, while home loans can be repaid within 15 years. You may have one general loan and one home loan at a time, but you can only request one loan—of each type—within a 12-month period.
If you’ve exhausted all other options and decide to take a 403(b) loan, make sure you understand the implications.
You’ll tie yourself up for automatic payments over the life of your loans. When you have an extra payment coming out of your paycheck, you might not be able to save as much in your 403(b) Plan (or 457(b) Plan) as you usually do—and that can have a significant effect on how much money you end up having in retirement.
When you borrow money, you pay yourself interest. If you took a loan as of May 1, 2017, you would pay yourself 5.0% 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 1967 and 2016, the average annual return was 10.2% for domestic stocks and 7.2% for bonds.2
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 (and California State income tax in most cases) on that amount. If you’re younger than age 59½, a 10% early withdrawal penalty (2½% State) may also apply.
Weigh the consequences on your future financial security before you tap your UC 403(b) Plan account. If you have access to other means of funding, such as home equity, a family member, or other viable sources, you should consider these options as well.
If you’re looking at a 403(b) Plan loan to help with unmanageable debt payments, call your creditors first. Lenders—including credit card companies—can be very accommodating when you need help making your payments sustainable.
Finally, if you can’t avoid borrowing from your account, try to repay your loan early.
1The 403(b) Plan’s interest rate is the prime rate in effect at the time of loan initiation plus 1%. According to Bankrate.com, as of May 1, 2017, the Wall Street Journal prime rate was 4.0%.
2Data Source: Ibbotson Associates 2017. 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.
The University of California intends to continue the benefits described here indefinitely; however, the benefits of all employees, retirees, and plan beneficiaries are subject to change or termination at the time of contract renewal or at any other time by the University or other governing authorities. If you belong to an exclusively represented bargaining unit, some of your benefits may differ from the ones described here.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
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