403b loan to pay off student loans

[hrain]

Hey all,

I've been reading up on retirement program loans and wanted to run something past all of you. I know that in general, taking a loan from your retirement accounts is bad because it reduces your time in the market and places your retirement financial security at risk. However, I was thinking about a specific circumstance where taking out the loan could be beneficial and want your input.

I'm a pgy2, my fiancé is a pgy1. Due to various savings from pre med school life and a generous and unexpected inheritance, we basically have enough to live on each year while throwing most of our own salaries into retirement accounts. As long as we continue down this path without any dramatic changes, I expect we could both end residency with ~80k in our 403b accounts, which would be fantastic. However, we do have a combined ~200k loan burden. Planning on repaye (our agi is minimal after pretax account contributions) during residency while refinancing after. What I'm considering however is each of us taking a 403b loan of ~50k towards the end of my fourth and final year of residency to just knock out about half of those loans. Then between the two of us (and as long as we don't dramatically alter our quality of living when I become an attending) we should probably be able to pay off the rest of the student loans plus repay the 403b loans (with prime+1% interest) within a couple years. This would just give us a way to take a big chunk out of those loans quickly even though we're obviously switching it for a different one rather than completely obliviating it right away...

Is that a reasonable reason to use a 403b loan? Obviously, there are times when this could hurt -- i.e. Happening to take a loan at the bottom of a market (which we just then wouldn't do) and buying back in high -- but if something like that can be avoided, would this plan make sense?

Thank you for the input!

PS - I did read that there is a "double tax hit" for paying back after tax money into the pre tax account, but wouldn't that after tax money be used to pay off loans and therefore isn't it basically the same amount anyway?

[jfoxcpacfp]

First off, you can borrow only the lesser of $50k or 50% of your 403b if the plan allows loans.

You really, really need financial planning - my first recommendation would be to invest in that (and/or hire a flat-fee student loan expert to help properly structure your loans). However, if I had to make a choice, given the limited information above, I would probably recommend using the inheritance to pay your tuition rather than borrowing from your retirement accounts (given only those 2 choices). Sometimes I think we try to play so much with all of the options that we miss the obvious.

I don't know about the double tax hit - can you provide a url or reference? Not sure how you can put after-tax $ in a pre-tax account.

Of course, I know nothing about your COL, the amount of the inheritance, whether having "free" money is affecting your spending habits, your short- and long-term goals, the diversification of your portfolio, etc. so this advice is probably worth about what it is costing you.

[hrain]

Hi Joanna,

Thank you so much for your reply. I really appreciate the input! I agree that at some point financial planning would be beneficial -- however, right now, I feel like I have a pretty solid plan (at least for the next 3-4 years of residency and beyond) and am actually putting it into action, which of course is the most important thing. Let me give a little more information for clarification:

We're both 28 y/o. I'm a PGY2, she's PGY1. No debt beyond the ~200k in student loans, which are in REPAYE.

My PGY2 salary: ~$54k, of which 18k->403b, 18k->457b, 5.5k->Roth, 7.5% (~4k)-> pre-tax DCP (mandatory contribution in place of SS for my residency), and ~7k->after-tax DCP which I roll into my Roth. I'm therefore saving ~50k per year into retirement accounts (~40 into pretax, 11-12 into after-tax). I have minimal taxes after all that since most of it is pretax. I'm also going to start moonlighting next year so will have a bit extra for retirement/loans/loosening up the purse strings somewhat if desired.

Fiancé's PGY1: ~52k, essentially to be split up the same way except that she'll likely keep more of her earnings rather than contributing to the after-tax DCP (although this kills me...I love that our program allows us to contribute so much to an after-tax and then do inservice w/d into the roth!). But she's still planning to contribute the full amount to the 403b/457b/pre-tax DCP/regular Roth.

Our AA is pretty aggressive, 90-95% stocks, 5-10% bonds. We've got some great options in our Fidelity 403b/457b/DCP, so most of our ERs are quite low and I'm very happy with our set-up from that standpoint. As for short-term goals, nothing big on the horizon (would love to buy a house but know it's not wise yet) except paying off our loans by 1-2 years post-residency and then starting to think about having kids and a house a couple years after that. Longtime, we'd both love to have the option to retire early (not sure if we would), by 50 y/o or so at the latest (or at least go part-time early to have more time with the kiddos. Both EM so should be pretty simple to scale back when we're FI.

As for your first point about borrowing the lesser of $50k or 50% of the 403b, my prospectus actually says $50k, 50% of total contributions (which I believe would include 457b?), or 100% of 403b, whichever is the lesser. So I think with the 457b, we could still each do 50k for the loan as it would be <50% of $160k total in pretax.

 

I definitely plan to use the inheritance towards our loans after graduation. It essentially is $50k that comes in each December, and so far we've managed to keep our COL below this and therefore be able to contribute our salaries to retirement accounts as above. Starting the December after I graduate, I plan to use leftover attending salary to live on and contribute the inheritance to our loans. That said, I definitely like the idea of paying myself a year or two of interest toward the 403b rather than racking up interest for an outside party on our loans....thus my wondering if it would make sense to take out the loans in addition to the inheritance to try to get rid of loans asap.

Oh, last thing: for the double tax hit, I think what it's referring to is paying taxes on the money initially that would be used to pay BACK the loan and then paying again when you withdraw the 403b funds in retirement...but what confuses me about this is that I'll have to pay taxes on the money anyway, whether it goes directly towards official student loans or towards paying back a 403b loan. Does that make sense? (Of course, in trying to find a URL for you, I instead found a Finance Buff article debunking this "double tax hit" myth to begin with...glad I could reason through it! https://thefinancebuff.com/401k-loan-double-taxation-myth.html )

 

Anyway, sorry that was so long, but you're right that you needed some more information. I really appreciate your input, and if you (or anyone else) have any more thoughts, please let me know!

[soundbyte]

I agree that I would use the inheritance to pay off the debt directly. Your numbers suggest you could pay off your loans entirely just 4 years but funneling your $50k/year into loans instead of retirement. With this inheritance you could presumably do it much sooner.

You do get the tax advantages by doing what you are currently doing. But at some point I think it's comes down to a personal feeling. Are you OK with student loan debt or would you rather be debt free? I would favor being debt free...

[jfoxcpacfp]

Thanks for the additional info. So, in essence, what you are doing at the tender age of 28 is borrowing money to fund your retirement accounts. Just not something I would feel comfortable with, especially w/o a sound financial plan that indicates that is a wise choice.

[hrain]

Hi Soundbyte, I definitely understand what you mean about the "personal feeling" about this. We actually went back and forth on it for a while before deciding that we are okay with the loans during residency but will pay them off ASAP afterwards. Part of this is that I cannot actually pay off any of her loans until after our wedding next year due to the gift tax rule. But the main reason for this is the exceptional options my residency provides for retirement benefits (the ability to contribute to 403b+457b+DCP pretax+megabackdoor Roth through aftertax DCP contributions) plus the knowledge that, if we continue to live like residents for ~2 years after residency, we'll be able to pay them back within that time with no issues and without having to cut back on retirement contributions. The way the numbers work out, after 5 years (my four years (one down!) plus her final year) of residency we'll have ~500k principal in retirement accounts split ~400/100 pre-tax to Roth but only ~230k in loans (based on REPAYE effective interest rate ~3-3.5% considering our very low AGI). However, if we were instead to put everything towards loans, we could pay them off in 3-4 years (probably 3, with gross takehome pay ~75k/yr (based on gross income and residency in California which adds significant state tax) not including the inheritance that we use to live on) but would a) be paying essentially full interest rate of ~6.5% since we would no longer get REPAYE subsidy; b) would end with little in retirement accounts. I know we're young and have time to put money in retirement accounts later, but I'd rather get a head start now since our program provides such good options and because I know we'll be able to pay the loans off in rapid succession once we're attendings. That said, if moonlighting 3rd+4th years ends up being pretty profitable, I definitely plan to start attacking them earlier!

Hi Joanna, I'm not quite sure what you mean -- I'm not borrowing any additional money to fund retirement accounts. I paid off my loans initially ASAP when the inheritance started, and what remains is my fiancé's amount (and I can't pay anything toward that until we get married next year anyway). At this point, I consider the loans our joint responsibility, but the IRS doesn't necessarily agree until 2017. But this, for me, is the age-old question of investing vs debt payoff, and during residency I think the winner (based on the numbers above, especially the REPAYE subsidy that we would lose if we started paying off loans next year instead) goes to investing. This may change when we have extra funds from moonlighting, which would decrease the subsidy and could allow us to pay off the loans even earlier. But we actually have a quite extensive financial plan and have so far put it into action quite well. I've run the numbers on this loan vs investing decision repeatedly, and numerically I know that investing wins out -- although of course, as Soundbyte mentioned above, there's definitely a feeling of emotional freedom being debt free that I'll miss until we pay off the loans. I do know we'll pay off our loans within 1-2 years of residency graduation regardless (and with extra aftertax money from the attending salary, rather than having to decrease retirement contributions), and at that point we'll be well on our way towards FI in terms of savings/investing as well. My question is primarily whether this would be a rare circumstance where taking a 403b loan at the end of residency makes sense, as (at that point) our effective interest rates would be significantly higher than during residency (unless we refinance) and we'll have the funds available in the 403b to cover it for the brief time until we pay them back entirely.

 

Thank you both for your input!

[jfoxcpacfp]

My comment had to do with the fact that you are borrowing (student loans) while funding $50k of retirement accounts annually. Seems pretty obvious to me.

Remember that simply funding your accounts has a relatively low effect on retirement age. The more important components are behavior and appropriate diversification and portfolio management. Of course, this is a portfolio-related comment only. The first thing you need is a real financial plan.

I wish you the best with whatever decisions you make!