A 403(b) plan is a type of retirement savings program available to some workers at public schools and nonprofits. Is this little-known retirement program worth looking into? Know how a 403(b) works and how it might affect your money and retirement before making a decision.
What Is a 403(b) Pension Plan?
Public school and nonprofit workers can put money away in a 403(b) retirement plan, which is an employer-sponsored retirement savings account.
Contribution limits, tax consequences, and withdrawal criteria are set by the IRS, making this account similar to a 401(k) retirement plan in many respects.
Both teachers and those who work for nonprofits have the option of having a portion of their compensation automatically deducted and deposited into a 403(b) account. The monies are placed in mutual funds and annuities with the hope that they will grow over time, albeit their growth is not assured.
Traditional 403(b) contributions are not included in taxable income since they are made before taxes. Instead, you’ll have to pay taxes when you cash out the funds from the account. If you contribute enough, you may be able to deduct a portion of your taxes through the Saver’s Credit. The 403(b) plan helps people save for the future in the same way that other retirement plans do.
The tax breaks are meant to incentivize employees to put money away for retirement, while the penalties for withdrawing money before retirement age are meant to deter people from doing so unless they have an emergency. The investment’s intended growth is compound interest, so you’ll get the most out of it if you start putting money in early and leave it there for a while.
Who Should Set Up a 403(b) Retirement Plan?
The 403(b) retirement plan is available only to the following employees:
- Volunteers working for a non-profit that falls under Section 501(c)(3). Taxes do not need to be paid by these groups. Employees of competing charitable organizations are not eligible (such as advocacy, fundraising, or political groups).
- Employees of the School District These are the faculty and administrative personnel of the institution. The Internal Revenue Service highlights the importance of employees’ participation in day-to-day school activities.
- Ministers. Pastors who are not working for a 501(c)(3) organization, are self-employed, or serve as chaplains in state prisons or the U.S. military are not eligible.
- Others. Workers at hospital cooperatives, tribal public schools, and the Uniformed Services University of the Health Sciences are also qualified.
A 403(b) may only be opened by an employee, with the exception of self-employed ministers.
401(k) vs. 403(b)
Primary distinctions between a 403(b) and 401(k) plan include:
- Eligibility. A 403(b) plan can only be offered by public schools and nonprofits, but 401(k) plans can be offered by any business (k).
- Cost. The costs associated with managing a 403(b) plan are typically lower than those of a 401(k), however these factors can vary widely between investment vehicles and managers.
- Choices for Financial Investments. Previously, only annuities could be placed in a 403(b) account, but the regulations have since been altered to allow for the purchase of mutual funds in this account as well.
You will not have the option to pick which plan to enroll in. You only have the choice to enroll in the plan offered by your company. The majority of qualified firms choose a 403(b) plan because it is less expensive to manage than a 401(k) and offers almost comparable benefits to employees.
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 risk over the long run, as the payout must be made regardless of the performance of the assets.
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 certain balance when you retire. Workers are on the hook if their retirement funds or investment portfolios suffer long-term losses or disappear altogether.
Pension plans are still available to employees at some public institutions and government agencies, but they are far less prevalent and have all but disappeared from the business world.
It all comes down to whether or not your company offers a pension or a 403(b) plan for retirement savings.
What Is a Roth 403(b)?
Like a Roth 401(k) or Roth IRA, a Roth 403(b) allows you to save for retirement with after-tax monies, meaning that you cannot claim a tax deduction for your contributions. In exchange, you can avoid paying taxes when you take money out of a Roth IRA or other similar account.
The main advantage of a Roth IRA over a standard 401(k) is that the taxes you owe when you withdraw your money will be lower than the amount you originally contributed.
The disadvantage of a Roth IRA is that you will not benefit from a current tax deduction, even though your current tax rate may be greater than your expected retirement tax rate.
You should consult a financial planner or investment consultant to assist you figure out whether or not making standard or Roth contributions makes more sense over the course of your working life. You are free to contribute to one or both accounts, but the maximum you may put into either or both is still the same.
The Benefits and Drawbacks of a 403(b) Plan
Does a 403(b) plan benefit those who work in education and the nonprofit sector? You should weigh the benefits and drawbacks of a 403(b) plan offered by your company before deciding whether or not to make a contribution.
403(b) Benefits
- Less Expensive to Manage Than a 401(k) (k). The administrative costs of 403(b) plans are often lower than those of 401(k) plans, which is good news for public and nonprofit organizations.
- Possibility of Employment Matching Programs. Your company may offer to double or even triple your contributions to your 403(b) account, depending on the company’s policies. If you don’t put in at least that much of your salary, you won’t get the tax break.
- Investments Managed by Employees. Many workers choose to let their retirement savings be managed automatically by a third-party agency. Investments in a 403(b) plan, in contrast to a pension, can be changed whenever the participant chooses.
- Limits of Contribution Are Greater Than Those of IRAs. If you don’t want to put money into a company’s 403(b) plan, an individual retirement account (IRA) is your next best bet, but in 2020, you’ll only be able to put $6,000 into one.
- Instances when you can catch up are specifically allowed. After age 50, you are eligible for a catch-up contribution to your tax-deferred retirement plan. That bump is part of a 403(b) plan, and if you’ve been with your company for at least 15 years, you may be eligible for an additional raise based on years of service.
403(b) Drawbacks
- Access is Restricted. 403(b) plans can only be offered by certain types of employers, including public schools, NGOs, and some religious and government agencies.
- Business Selects Investment Management Company. Your company, not you, decides who handles the investments for your 403(b) plan. It’s possible that you won’t be happy with the firm’s customer service, policies, or costs. An IRA, on the other hand, can be established wherever you choose, and you can transfer it whenever you like.
- There is no assurance of any kind of benefit. Your retirement funds in a 403(b) plan are exposed to stock market risk, unlike a pension or savings account.
Contributions under Section 403(b)
You and your employer can agree on an amount for your 403(b) contributions to be deducted from each pay period.
Contribution Limits in 403(b) in 2020
The maximum annual contribution to a 403(b) is age- and method-specific. Limits on contributions to a 403(b) for employees under age 50 are as follows:
- Optional Deferrals (Your Payroll Deductions). In 2020, the yearly cap for 403(b) payroll contributions is $19,500.
- Yearly Additions. The overall annual contribution maximum for your 403(b) in 2020 is $57,000, including your contributions, your employer’s match, and any after-tax contributions.
After the age of 50, you can make additional annual payments, known as “catch-up contributions.” Workers over the age of 50 have an opportunity to put away an extra $6,500 into their 403(b) accounts in 2020.
Different from other retirement plans, 403(b) accounts provide a provision for those with more years of service to contribute. Catch-up payments of $3,000 per year, up to $15,000 over multiple years, are available to employees aged 50 and over who have worked for their current company for at least 15 years. Therefore, the sum of all 403(b) contributions for 2020 is:
- Workers aged 49 and under: $19,500
- Workers above the age of 50: $26,000
- Workers above the age of 50 with at least 15 years of service: $29,000
You may want to increase your annual retirement savings. 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, that number rises to $7,000.
Where Do 403(b) Contributions Go?
Financial services firms like TIAA-CREF and Fidelity are often hired by businesses to oversee and manage their 403(b) plans for its employees. The goods and services offered by the company you choose to invest with will determine the types of mutual funds and annuities from which you can select.
It’s likely that when you sign up, you’ll be given the choice to have your money invested in the investing firm’s default portfolio. You may pick and choose which mutual funds or annuities you put your money into depending on how hands-on you want to be. However, unlike with an individual retirement account (IRA), 403(b) plans prohibit direct investment in specific equities.
403(b) Withdrawal Regulations
A 403(b) account is a type of retirement savings plan, thus withdrawals must be made only during certain time periods. Even while the funds are technically yours at all times, early withdrawals are subject to a tax penalty in order to encourage long-term savings and justify the tax incentives.
How and When Can You Take Money Out of Your 403(b)?
Generally speaking, you won’t be able to cash out your 403(b) until you’ve met the following conditions:
- You’re 59 1 and 1/2 years old
- You are 55 years old and have retired.
- You pass away (survivors or beneficiaries receive distributions)
Early withdrawals are subject to a 10% penalty in addition to income taxes. You must include that cost with your annual tax filing.
Withdrawal Due to Difficulties
While you’re still employed, you can take an early distribution from your 403(b) if you’re experiencing financial hardship. The majority of banks and other financial institutions enable customers to withdraw money at times of extreme difficulty.
- Medical Expenses. These are significant, unreimbursed costs incurred by you, your spouse, or your dependents.
- Home Purchase Payment. This is authorized only for primary residences and not rental homes.
- Tuition and associated fees. The money must be used for higher education expenses due within the following 12 months.
- Eviction or Repossession. This can be used to pay your rent or mortgage if you have no other income or assets.
The 10% early distribution penalty and ordinary taxes apply to hardship withdrawals as well.
403(b) Loans
You can take out a loan against your 403(b) account up to the lesser of $50,000 or 50% of the account’s value, if permitted by the company holding your account.
The interest rate that customers pay is determined by the company but is often in line with market averages. The loan is considered an early distribution and the 10% tax is due in the year you receive the loan. A 403(b) loan has a five-year repayment term and carries severe tax penalties for non-payment.
403(b) Distribution Taxes
Distributions from a 403(b) are subject to normal income taxation unless they are made from a Roth account. Your tax bracket will be based on the sum you receive and any other income you have that year.
The same taxes plus a 10% penalty will apply to any withdrawals made before the withdrawal date.
If you expect to take a big sum in retirement or early as a hardship withdrawal or loan, you may want to consider making quarterly projected tax payments to avoid a huge tax bill and underpayment penalty come April.
Distributions that are required
Once you’re able to do so, you can access your 403(b) account whenever you choose up until you are 70 and a half. After that point, you must take out a certain amount each year or be subject to a tax.
Required minimum distributions are calculated using the account balance and the account owner’s age. Required minimum distributions can be calculated with the use of IRS spreadsheets (RMDs). The computed RMD is meant to draw down all of your retirement resources throughout your lifetime and is based on life expectancy.
Bottom Line
Workers in public education and the nonprofit sector can take advantage of tax breaks by contributing to a 403(b) retirement savings plan. Having access to a 401(k) via work may be a great way to save for the future, especially if your company matches your contributions.
Investing in mutual funds that are appropriate for your risk tolerance and financial condition is a great way to get the most out of your 403(b) plan. For instance, investors’ risk tolerance shifts over time, from higher when they’re young to lower as retirement approaches.
One of the easiest and most effective methods to save for retirement is through a tax-advantaged, employer-sponsored account, however retirement savings can be made through a variety of investment vehicles. Saving early allows you to get more rewards from investment returns due to compound interest.
Don’t let the specifics scare you. You should be able to get help opening a 403(b) account from someone in your company’s human resources department. Having money saved automatically out of each paycheck is a real perk. If you decide to quit your work, you may always transfer the remaining value to an Individual Retirement Account (IRA) or another retirement account.
