Default of 403b loan?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
lilyn20
Posts: 7
Joined: Tue Mar 27, 2018 5:09 pm

Default of 403b loan?

Post by lilyn20 » Fri Sep 14, 2018 2:13 pm

My 73-year old father in considering defaulting on a loan from his retirement account. I don't have exact amounts, but I believe the account balance is around $450k, and his only other income is from social security (approx $2.4k / mo); no other investments. His rationale is that he doesn't have enough cash flow to repay the loan. He is looking at withdrawing a $200k lump-sum to cover the costs of getting into a 55+ community in a lower cost of living area and paying some outstanding medical bills. This would leave $250k, and I think the loan is about $40k.

I haven't seen the terms and conditions of the loan, but I would assume that it makes more sense to draw down enough money to make the payments according to the schedule instead of defaulting. My thinking is that 1) he avoids the one-time tax hit, and 2) the undrawn money continues to generate some small return in the meantime. He is very conservatively invested with most in a Stable Value fund.

Am I completely off-base in how I'm seeing this?

Silk McCue
Posts: 1120
Joined: Thu Feb 25, 2016 7:11 pm

Re: Default of 403b loan?

Post by Silk McCue » Fri Sep 14, 2018 3:06 pm

If the $40k loan is from the account that has $450k in it there is no reason that he can't pay off this loan. Not paying off that loan is going to cause him (and I expect you) more headaches than he wants. If he pulls $200k from the tax deferred retirement account he will be trounced with taxes as a single filer and that would be a tragic and unnecessary mistake ($46k Federal Income Tax). In addition, the large drawdown would likely cause 85% of his Social Security payment to be subject to income taxes at the 32% bracket. Its all much worse if there is a State income tax

A sane plan of pulling from the 403b each year up to some maximum marginal rate (22%) (including eventual SS taxation) needs to be looked at. At 73 he may have many years left ( and more than he may appreciate). Making the wrong decisions now will have severe consequences.

Hopefully others will come along with additional input.

Cheers

delamer
Posts: 5837
Joined: Tue Feb 08, 2011 6:13 pm

Re: Default of 403b loan?

Post by delamer » Fri Sep 14, 2018 3:45 pm

He won’t actually default on the loan; after all, it is his own money.

What will happen is that the unpaid balance becomes a distribution and he’ll have to pay income taxes.

As Silk McCue said, he’ll have a huge tax hit if he withdraws $200,000 from his account in one year. And if he actually needs $200,000 to spend, he’ll need to take out a lot more from his account. At a 22% income tax rate, he’d need to take out over $250,000.

User avatar
grabiner
Advisory Board
Posts: 22563
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Default of 403b loan?

Post by grabiner » Fri Sep 14, 2018 8:26 pm

delamer wrote:
Fri Sep 14, 2018 3:45 pm
He won’t actually default on the loan; after all, it is his own money.

What will happen is that the unpaid balance becomes a distribution and he’ll have to pay income taxes.
So it will be treated as if he withdrew the money from the account, and then put it right back in to pay off the loan at once.

And this is a bad idea in a year in which he is in a high tax bracket. He should take out enough extra to make the loan payments this year. Then, in 2019, if he is in a lower tax bracket and does not want to keep the loan, he can withdraw enough to pay off the remaining balance.
Wiki David Grabiner

delamer
Posts: 5837
Joined: Tue Feb 08, 2011 6:13 pm

Re: Default of 403b loan?

Post by delamer » Fri Sep 14, 2018 8:42 pm

grabiner wrote:
Fri Sep 14, 2018 8:26 pm
delamer wrote:
Fri Sep 14, 2018 3:45 pm
He won’t actually default on the loan; after all, it is his own money.

What will happen is that the unpaid balance becomes a distribution and he’ll have to pay income taxes.
So it will be treated as if he withdrew the money from the account, and then put it right back in to pay off the loan at once.

And this is a bad idea in a year in which he is in a high tax bracket. He should take out enough extra to make the loan payments this year. Then, in 2019, if he is in a lower tax bracket and does not want to keep the loan, he can withdraw enough to pay off the remaining balance.
That might make sense if it wasn’t for the other $200,000 that he is talking about withdrawing. He needs to do a thorough tax analysis.

User avatar
grabiner
Advisory Board
Posts: 22563
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Default of 403b loan?

Post by grabiner » Fri Sep 14, 2018 8:44 pm

delamer wrote:
Fri Sep 14, 2018 8:42 pm
grabiner wrote:
Fri Sep 14, 2018 8:26 pm
delamer wrote:
Fri Sep 14, 2018 3:45 pm
He won’t actually default on the loan; after all, it is his own money.

What will happen is that the unpaid balance becomes a distribution and he’ll have to pay income taxes.
So it will be treated as if he withdrew the money from the account, and then put it right back in to pay off the loan at once.

And this is a bad idea in a year in which he is in a high tax bracket. He should take out enough extra to make the loan payments this year. Then, in 2019, if he is in a lower tax bracket and does not want to keep the loan, he can withdraw enough to pay off the remaining balance.
That might make sense if it wasn’t for the other $200,000 that he is talking about withdrawing. He needs to do a thorough tax analysis.
This is why I recommend not defaulting in 2018 (nor paying the whole loan off without a default). Any additional withdrawals made in 2018 will be at a higher tax rate than in 2019.
Wiki David Grabiner

krow36
Posts: 1817
Joined: Fri Jan 30, 2015 6:05 pm
Location: WA

Re: Default of 403b loan?

Post by krow36 » Fri Sep 14, 2018 8:47 pm

You might find this thread about 403b loan default interesting: http://board.403bwise.com/topic/6846-40 ... -question/

delamer
Posts: 5837
Joined: Tue Feb 08, 2011 6:13 pm

Re: Default of 403b loan?

Post by delamer » Fri Sep 14, 2018 8:51 pm

krow36 wrote:
Fri Sep 14, 2018 8:47 pm
You might find this thread about 403b loan default interesting: http://board.403bwise.com/topic/6846-40 ... -question/
But the father is over 59.5.

lilyn20
Posts: 7
Joined: Tue Mar 27, 2018 5:09 pm

Re: Default of 403b loan?

Post by lilyn20 » Fri Sep 14, 2018 9:56 pm

Thanks all for the input. I am going to sit down with him to try and get more details and see if we can do the total withdrawal (including the minimum loan repayment) in a more tax-efficient way, especially considering that we are nearing the end of the year. If he can spread out some of the expenses until January, maybe it will take some of the sting out of the tax bite.

Rwsawbones
Posts: 27
Joined: Fri Jan 20, 2017 11:21 pm

Re: Default of 403b loan?

Post by Rwsawbones » Fri Sep 14, 2018 10:15 pm

It gets worse. The medicare part B and part D premiums go up with one’s adjusted gross income which makes it a bad idea to take a large distribution at one time

lilyn20
Posts: 7
Joined: Tue Mar 27, 2018 5:09 pm

Re: Default of 403b loan?

Post by lilyn20 » Fri Sep 14, 2018 10:30 pm

That's also an important point I hadn't considered. Will factor that into the discussion and subsequent plan.

Post Reply