Maybe you’re struggling with debt right now. Maybe you’re just annoyed with the high interest-rate your credit card provider charges you every year, so you want to pay off your debt. Then you remember you have a 403(b) retirement account and the money is just sitting there. Better to take advantage of it, you think?
“Can I take money out of my 403(b) to pay off debt?” The short answer is yes. But is it worth it? Should you even do it? Let’s explore that in this article.
Can you withdraw money from your 403(b)?
Yes, you can withdraw money from your 403(b), however, there are certain conditions to be met before you can do this.
There are two ways you can get money out of your 403(b) retirement plan: via loans or withdrawals.
Generally, to withdraw from your 403(b) retirement account without any penalties, one of the following measures must be met in order to access the funds in your retirement account:
- Be at least 59 ½ years of age
- Severance of employment (after 55 years of age)
- Disablement or death
- Financially distressed
Withdrawals that qualify for any of the above measures will be taxed at your regular income tax rate (with exception of Roth 403(b) account holders)
However, early withdrawals made before your plan's retirement age that do not meet any of the conditions above will incur a 10% income tax of the amount withdrawn.
Withdrawing from your 403(b) early
Now, let's go through the different ways you can take money out of your 403(b) account early, and different methods of withdrawal when it comes to your account.
You can take take out money from your 403(b) to pay off debts with an early withdrawal. An early withdrawal before the stipulated retirement age of your plan is subject to a 10 percent income tax of the amount withdrawn. Retirement withdrawals are considered income because the contributions and growth are tax-deferred, so you will have to pay tax for them.
If you want to borrow money from your 403(b) to pay off a loan, you can do so via a loan from your 403(b). If you borrow money from your 403(b) account via a loan, the loan must be paid back to your retirement account and is not taxed as long as you keep up with the repayment promptly.
You can borrow up to 50 percent of your retirement account balance or a maximum of $50,000, whichever is lower. However, if the balance is less than $10,000, you can borrow up to $10,000.
You have five years to repay the amount you borrowed plus interest. If you use the loan for education and home improvement, you’ll have longer repayment terms up to 15 years. The interest rate is typically the current prime rate when you took the loan, plus 1 percent. The payment schedule is every quarter.
Here’s a calculator you can use to compute the true cost of your retirement loan.
If you can’t pay the loan within the allotted period, it will be treated as an early withdrawal, which means you’ll have to pay 10 percent income tax of the amount you borrowed as a penalty. If you missed one payment schedule, your loan will be considered as distribution, so you need to pay the penalty to the IRS when you filed your income tax for the year.
Can you pay off a 403(b) loan early? Definitely. If you find yourself in a better financial situation after borrowing from your 403(b) account, you can pay your loan back in a lump sum if you’re able to. And there’s no penalty if you do so.
If you're in dire need for financial support and you can prove your case, you can also take a hardship withdrawal. In that case, the loan is limited to the amount that would satisfy your financial need. What circumstances are acceptable depend on the plan. For example, your 403(b) plan must specify that hardship withdrawals are allowed for medical expenses and funeral costs for you to be able to make these withdrawals.
There are a total of 6 situations that can qualify you for a hardship withdrawal if your plan allows it. These situations include:
- Amounts paid for medical care provided to employees, their spouses, children, or beneficiaries.
- The costs directly associated with the purchase of the employee's principal residence (mortgage payments do not apply)
- Expenses associated with tuition, related educational fees, and room and board for the employee or his or her spouse, children, dependents or beneficiaries for the next 12 months.
- An employee's principal residence is at risk of eviction or foreclosure due to foreclosure payments.
- Employer, spouse, children, dependents, or beneficiary funeral expenses.
- Costs associated with repairing certain damages to the employee's principal residence.
Your employer and plan will determine if your dire financial needs are valid based on facts and circumstances.
How To Withdraw From Your 403(b)
Taking out a loan from your 403(b) retirement plan is quite similar to the usual loan application from other lenders. But with 403(b), there’s no credit check conducted and the process is rather quick.
You must secure a loan application form from your 403(b) plan provider, such as this one from Aspire. Your employer usually chooses the 403(b) provider but may allow you to choose your own from a list of predetermined vendors.
Fill out the necessary details and submit the form. Some institutions process the request on the same day it was submitted. When it’s approved, the fund is sent via direct mail or bank transfer (depending on what you choose) the next business day. You can have your funds in a few days.
Weigh in – Pros & Cons Of Borrowing Money From Your 403(b)
Taking loans and withdrawals both have pros and cons. To decide which option is best for you, you must weigh these up. Let’s take a look at what it entails to borrow or cash out from your 403(b) retirement account.
- It’s easy to obtain. The process is relatively easy compared to getting a loan from other lenders that have stringent requirements and paperwork. So, if you need money immediately, a 403(b) loan or withdrawal is a quick source.
- It has a low-interest rate. Compared to what you pay credit cards, 403(b) loan interests are up to 70 percent lower. If you’re refinancing credit card debt, this is a good option.
- The interest you pay goes to your account. When you have repaid the amount you loaned, the interest helps build your account instead of going to the financial institution. Ultimately, the interest you paid belongs to you.
- It doesn’t affect your credit score. Your 403(b) loan is technically not a debt, so it doesn’t affect your credit score and your chances of getting approved for a traditional loan.
- You don’t have to return early withdrawal. If you cash out on your retirement savings, you don’t have to return the money to your account.
- You’re taxed twice essentially. Your loan repayment comes from your after-tax income, and then you pay full income tax when you get your distributions.
- You pay penalties and taxes when you default. If you default on the loan, you have to pay a 10 percent penalty plus income tax on your entire loan amount. Your early withdrawal is also considered an income and is therefore taxable.
- There’s an opportunity cost. Your retirement account is designed for long-term investments. Taking out loans and early withdrawals from it can stunt the growth of your assets.
Using 403(b) to pay off debt
It’s best not to take out money from your 403(b) retirement plan and if you really have to then use it as your last option. That way, you won’t lose the benefits of compounding interests that will help grow your assets. Other than taking out a retirement loan, you can explore alternative ways to pay off your debt.
1. Consolidate Your Debt
If you have multiple debts, you can check if your bank or credit union can help you consolidate them into one personal loan with lower interest. You may end up paying less money than you would with individual debt.
2. Use the Snowball Method
Pay the minimum amount due on all your accounts. Then, put the extra money you have on the account with the smallest balance. Once you’ve paid off that smallest account, put the money to the next account with the smallest balance. These little successes get you off on a good start and make you feel more motivated because you see that you’re making progress.
3. Use the Avalanche Method
Alternatively, you may target the account with the biggest interest. Pay the minimum on all your accounts, then funnel the extra cash you have to the one with the highest interest rate. You may not see immediate progress, but as you pay off the debt with the highest interest, you free up more money for the next account.
4. Take Advantage of Balance Transfers
If you have a couple of credit cards, you can transfer the balance from the one with the highest interest to another that has a lower interest. Most cards offer a zero percent interest on balance transfer, so you can take advantage of it to put your debt under control and pay them all eventually.
5. Opt for Debt Settlement
If you’re significantly past-due with your payments, you may consider a debt settlement with your creditor or the collections agency. In this method, your creditor might reduce the amount you have to pay by around 50 percent if you can pay that in a lump sum. The other half is forgiven, but you may need to pay taxes.
6. Ask for Lower Interest Rates
If you’ve been paying consistently and have a good credit history, you may ask your credit card issuers for lower interest rates. That will allow you to free up money that you can use to pay your debt.
Being in debt is never a good experience, and it’s best to take steps to manage it before it gets out of hand. Your 403(b) retirement account sounds like a good idea to help you settle some debts, but it’s best not to touch it and if used, only as a last resort. You have alternatives that you can explore, and while it may take some time to clear your debt, you’ll end up paying less money. Not to mention, you’ll keep your retirement future secured.
Have you taken out a 403(b) loan or withdrawal before? We’d love to hear your experience in the comments below!