There is a possibility that a 403(b) plan will be available to you if you work for a public school or a nonprofit. Is this little-known retirement plan worth considering, and what exactly does it entail?
Know the ins and outs of a 403(b) and how it can affect your retirement savings before making a final decision.
Understand the 403(b) Retirement Plan.
Employees at government agencies and charities can put money away for retirement through a 403(b) plan, which is an employer-sponsored retirement savings account.
Similar to 401(k) plans, employees sign up with their employers in the hopes of receiving a matching contribution, and the Internal Revenue Service (IRS) regulates the maximum amount that can be contributed each year, the tax consequences of withdrawing funds, and the restrictions for early withdrawal.
Automatic payroll deductions allow teachers and other nonprofit workers to save for retirement through a 403(b). This is a long-term investment with the potential for growth through annuities and mutual funds, but the rate of return is not guaranteed.
You can reduce your taxable income by the amount you contribute to a typical 403(b) before taxes are taken out. The taxes will be paid when the money is taken out of the account. When filing your taxes, you may be able to take advantage of the Saver’s Credit.
A 403(b) can be thought of as a retirement plan in that it encourages long-term saving. There are tax breaks to motivate workers to put money down for retirement, and a penalty for withdrawing funds early to discourage speculative spending.
The investment is designed to increase over time with compound interest, so the best results come from starting early and keeping money in the account for a long time.
To Whom Should a 403(b) Retirement Account Be Opened?
A 403(b) retirement plan is only available to the following employees:
- Personnel of Tax-Exempt Organizations. Nonprofit organizations such as these are exempt from paying taxes. Workers for other charitable groups (such as lobbying, fundraising, or political) are not qualified.
- Employees of a public school system. Everyone on staff is included in this. According to the IRS, workers must participate in the running of the school on a regular basis.
- Ministers. In order to qualify, pastors must work for a non-profit organization that meets the requirements of Section 501(c)(3), be self-employed, or serve as a minister or chaplain for an entity that does not meet those requirements, such as a state jail or the United States Armed Forces.
- Others. Additionally, civilian personnel of the Uniformed Services University of the Health Sciences, hospital cooperatives, and tribal public schools is all welcome to apply.
To qualify for a 403(b), you typically need to be employed by a firm, though pastors who are self-employed are an exception.
401(k) vs. 403(b)
To briefly compare a 403(b) plan to a 401(k) plan, we can say the following:
- Eligibility. A 403(b) plan can only be offered by public schools and nonprofits, but a 401(k) plan can be offered by any business (k).
- Cost. Costs associated with managing a 403(b) plan are typically lower than those of a 401(k), though this might vary based on the investment vehicles and advisors used.
- Alternatives for Putting Money Into Investments. The rules used to only allow annuities to be placed in a 403(b) account, but that changed several years ago.
- You will be required to join one of the plans offered. The plan your company provides is the only one available to you. Because of its lower administrative costs compared to 401(k) plans, a 403(b) plan is preferred by most qualifying businesses.
Pension vs. 403(b)
A pension is a sort of retirement savings in which the retiree is promised a specific amount of money each month once they stop working. The employer takes on the long-term risk, as the payout must be made regardless of the performance of the investments.
In contrast, defined-contribution plans like 401(k), 403(b), and individual retirement accounts (IRAs) require you to contribute a certain amount each year but do not guarantee a specific balance when you retire. Employees are taking on the risk that their retirement savings and investment portfolios may decline in value over time.
Pension plans are still offered by some public institutions and government agencies, although private businesses rarely do. Whether or not you participate in a 403(b) or pension plan for retirement depends on the options available through your place of employment.
How Does a Roth 403(b) Work?
Similar to a Roth 401(k) or Roth IRA, contributions to a Roth 403(b) are made with after-tax dollars. When you make a withdrawal from a Roth IRA, you won’t have to worry about paying taxes on the money.
One advantage of a Roth IRA over a typical 401(k) or 403(b) is that you pay taxes on your contributions up front, on an amount that will likely be less than what you withdraw in the future due to returns on your investment.
The disadvantage of a Roth IRA is foregoing a current tax deduction at a time when your tax rate could be higher than it will be in retirement due to increased earnings.
Find out whether making standard or Roth contributions makes more sense for you over the course of your career from a financial planner or investment adviser. You are free to allocate your contributions between the two accounts, but the combined maximum remains the same.
Disadvantages and Advantages of a 403(b) Plan
Does a 403(b) plan benefit those who work in education and the nonprofit sector? Weigh the benefits and drawbacks of a 403(b) plan offered by your company before deciding whether or not to make a contribution.
- Lower Administrative Costs Than a 401(k). Compared to 401(k) plans, 403(b) plans tend to be less expensive to manage, which is great news for public and nonprofit organizations.
- Possibility of Employment Matching Program. The amount you put into a 403(b) account may be matched by your employer up to a certain percentage. You will lose this perk if you choose not to give at least that much of each paycheck.
- Collectively Owned Investments by Workers. Employees often choose to have their retirement savings managed by a third party and set on autopilot, allowing the firm to make investment decisions on their behalf. In contrast to a pension, however, your 403(b) investments give you more flexibility.
- More Room to Put Money In Compared to an IRA. If you don’t want to save in a company-sponsored 403(b), an IRA is your next best bet, with a limit of $6,000 per year in 2020 compared to the $19,500 cap on a 403(b).
- This is a unique provision for catching up. There is a catch-up provision in every qualified retirement plan that allows you to contribute more each year once you turn 50. If you’ve worked with your company for at least 15 years, you can increase your contribution limit even further under a 403(b) plan thanks to years of service catch-up.
- Eligibility Restrictions Apply. A 403(b) plan can only be provided to workers of public schools, nonprofits, and some religious and government organizations.
- The Business Selects Its Own Investment Manager. While you have some say in how your business invests the money in its 403(b) plan, that decision ultimately rests with the company. You may find that you don’t like the company’s pricing, policies, or customer service. The location of your IRA opening and subsequent account transfers are entirely under your hands.
- There is no Assurance of Gain. Retirement funds in a 403(b) plan are exposed to stock market risk, unlike pensions and savings accounts.
An employee’s company will deduct predetermined amounts from each pay period to be deposited into a 403(b) account on the employee’s behalf.
2020 403(b) Contribution Limits
The maximum annual contribution to a 403(b) depends on your age and the method of depositing funds into the account.
Workers under the age of 50 faces the following 403(b) restrictions:
- Intentional Postponements (Your Payroll Deductions). In 2020, the maximum salary reduction contribution to a 403(b) plan will be $19,500 per year.
- New Content Each Year. There is a $57,000 annual cap on 403(b) contributions in 2020. This includes employee and employer contributions, as well as any after-tax contributions.
- When you reach the age of 50, you can start making catch-up contributions, which allow you to increase your annual contribution amount. For the year 2020, employees aged 50 and up can put away an extra $6,500 into their 403(b) plans.
- The years-of-service catch-up option is a feature exclusive to 403(b) accounts. It’s possible to put in an extra $3,000 annually in catch-up payments if you’re 50 or older and have worked for the same company for at least 15 years, for a total of $15,000 over several years.
Consequently, the sum of all 403(b) contributions for 2020 is:
- Workers 49 and Younger. $19,500
- Workers 50 and Older. $26,000
- Workers 50 and Older with at Least 15 Years of Service. $29,000
If you’re looking to increase your annual retirement savings, read on. The 403(b) plan isn’t the only retirement account option (b). In 2020, the maximum IRA contribution is $6,000. If you’re 50 or older, you can increase it to $7,000.
What Institutions Invest 403(b) Contributions?
Investment management and administration for a company’s 403(b) plan is often outsourced to a financial services firm like TIAA-CREF or Fidelity through a contract with the employer.
Typically, you can choose from a wide range of mutual funds and annuity products, though your actual options may vary based on the specific company you invest with.
It’s likely that when you sign up, you’ll be given the choice to have your money invested in the investment firm’s default portfolio. It’s up to you to decide how involved you want to be by investing in a variety of different funds and annuities.
However, unlike with an individual retirement account (IRA), 403(b) contributions cannot be made directly to individual stocks.
Your retirement savings are portable and won’t be affected by your decision to leave your current employer.
You can transfer your 403(b) to:
- A fresh 403(b), assuming your new workplace provides one
- Your new company’s 401(k) plan, assuming they have one
- An IRA If you don’t want to start a new work that provides a retirement account, don’t want to invest with the company, or don’t want to start new employment at all.
A Roth account cannot be converted to a regular one. It is possible to convert a standard retirement account into a Roth IRA, but doing so will result in taxable income in the year of the conversion.
Your new account’s withdrawal policies, contribution restrictions, and tax consequences will apply after a rollover.
How to Begin a Rollover 403(b)
The investment firm that oversees your previous employer’s retirement plan is contacted to begin the rollover process. If you don’t know, ask your former company for such data before you depart.
Rollovers can typically be initiated through an investor’s online account. When everything else fails, give the company a call. To initiate a rollover with certain companies may cost you up to $50.
Once you’ve requested a rollover, the company will let you know whether the cash will be sent to you in the form of a paper check or placed electronically into your new retirement account. You must follow the directions on the check carefully if you want to avoid having to report the money as income and pay taxes on it.
Rules for 403(b) Withdrawals
In order to encourage people to save for retirement, a 403(b) account limits withdrawals to specific times of the year. Your money is always at your disposal, but in order to encourage long-term savings and provide some justification for tax incentives, early withdrawals are subject to fees.
When Is a 403(b) Withdrawable?
In most cases, you won’t be able to cash out your 403(b) until you’ve met the following conditions:
- You’re 59 1/2 years old
- You’re 55 years old and retired
- You die (survivors or beneficiaries receive distributions)
An additional 10% penalty on top of your regular income taxes will be imposed if you cash out early. The annual tax return is where you add that cost.
Any payout taken out of your 403(b) while you are still employed is considered a hardship withdrawal. Most banks and other financial institutions will let you take out cash in times of extreme difficulty.
- The Cost of Healthcare. These are significant out-of-pocket costs that you, your spouse, or your dependents have incurred.
- Paying the Initial Expenses Related to Purchasing a House. This is only allowed for primary residences and not rental units.
- Educational Costs. The money is only for tuition payments within the next calendar year.
- In other words, you’re facing eviction or foreclosure. If you have no other means of supporting your living expenses, this can serve as a substitute for your rent or mortgage payment.
The 10% early distribution penalty and ordinary taxes apply to hardship withdrawals as well.
You may withdraw as much as $50,000 or 50% of the account’s value, whichever is less, from your 403(b) if the company holding your account permits withdrawals.
Depending on current market conditions, the company decides on an interest rate. A loan is considered an early distribution and the 10% tax penalty is due in the year the loan is disbursed.
Repaying a 403(b) loan is mandatory within five years, and there are severe tax implications for not doing so.
403(b) distribution taxes
With the exception of withdrawals made from a Roth 401(k) plan, disbursements from a traditional 401(k) will be taxed at your usual income rate. Your tax rate is a function of your total income for the year, including any gifts or inheritances you may receive.
An early withdrawal will result in the same taxation plus a 10% penalty. Consider making quarterly anticipated tax payments to prevent a hefty tax bill and underpayment penalty comes April if you anticipate withdrawing a large sum, either in retirement or early as a hardship withdrawal or loan.
Until you become 70.5, you have complete freedom to take as much or as little as you choose out of your 403(b) account. After that, you’ll be subject to a yearly withdrawal requirement or a tax penalty.
The amount of the needed minimum payout is calculated using the total value of your account and your age. If you need help calculating your RMDs, the IRS has spreadsheets available (RMDs).
Your Required Minimum Distribution (RMD) is computed using your expected life span and is meant to ensure that your whole retirement nest egg is spent during your lifetime.
Employees in public schools and nonprofits can benefit from a tax-deferred retirement savings plan known as a 403(b). Employer-sponsored retirement plans, especially those that match employee contributions, might be a great way to save for the future if you’re eligible.
You can get the most out of your 403(b) if you invest in mutual funds that are appropriate for your risk tolerance and life circumstances. In general, investors’ risk tolerance shifts with time, with younger investors willing to take on more danger as they build their portfolios and older investors becoming more risk-averse as they approach retirement age.
One of the simplest and most prudent methods to save for retirement is through a tax-advantaged, employer-sponsored account. The power of compound interest increases with the length of time an investment is held, therefore it’s best to start saving as early as possible.
The level of specificity should not scare you. The human resources staff at your employer should be able to assist you in creating a 403(b) account. Automatically save money thanks to pre-tax payroll deductions. And even if you leave your employment, you may always transfer the funds to an IRA or another retirement account.