Borrowing money from your 403(b)

[Alejandra Tapia]

My tax preparer recently mentioned the possibility of taking out a loan from my 403(b). He mentioned that a good thing about this is that I would pay back the money to myself, with interest, as opposed to the government keeping a percentage once I take out the funds from my 403(b).

Could someone elaborate on this for me? Or provide some further clarification?

Much appreciated!

Alex

[Dmitriy Fomichenko]

Originally posted by @Hessel Pole:

I've spent the past couple of months researching this topic and came up with the same conclusion as Mike S. Mortgaging real estate within an SDIRA triggers a GIGANTIC TAX from Unrelated Debt-Financed Income (UDFI). The tax applies to Self-Directed IRAs and can be as much as 37% on the gains you make from the loan portion of your property.

A self-directed Qualified Retirement Plan (QRP) is the answer to avoiding the UDFI taxes in leveraged real estate investing. They also have a myriad of other benefits including the flexibility and power to invest in the gamut of asset classes alternative investments, contribution limits, checkbook control, etc. But not every QRP is created equally! Some have the liability protections of a multi-member 401k, while others do not. 

Hessel,  

While you are correct that the highest level of UBIT is 37%, that is not how much you are going to pay. When calculating this tax you are able to take normal deductions such as mortgage interest, property tax, insurance, depreciation, repairs, etc. The net income after applying this deductions will then be subject to UBIT. It will not be as bad as you present it to be (for most people anyway), especially given the fact that by using leverage you are significantly increasing your ROI.

QRP is a general term which applies to a number of qualified retirement plans. Sometimes it is referred to truly self-directed Solo 401k plan. You are also correct that it would be exempt from UDFI, therefore avoiding UBIT on leveraged real estate. This plan is not for everyone, however. One must have legitimate self-employment activity or business with earned income in order to qualify. But I totally agree with you, if eligible - this would be a superior vehicle to SDIRA.

Here is a related in-depth discussion on the subject that many readers can benefit from:

https://www.biggerpockets.com/forums/51/topics/527877-self-directed-solo-401k-for-real-estate-investors-q-and-a