Unless you are an employee of a tax-exempt organization, like a public school, you may be unfamiliar with a 403(b). A 403(b) is a type of retirement account explicitly designed for employees of public schools, like teachers and other tax-exempt organizations. This article will discuss what a 403(b) plan is, how it works, and how to maintain it.
What is a 403(b) Plan?
A 403(b) plan, also referred to as a tax-sheltered annuity plan or TSA plan, is a retirement plan offered by tax-exempt organizations, mainly public schools, and charities, for certain employees.
Eligible employees work at:
- A public school, college, or a university. They are generally teachers, professors, administrators, government employees, doctors, nurses, and librarians.
- A church.
- A tax-exempt charity under Section 501(c)(3) of the Internal Revenue Code.
403(b) plans are similar to 401(k) retirement plans. Both 403(b) and 401(k) allow employees to defer a portion of their salary into a retirement account. Also, employers may match a part of the employees' contributions.
The funds invested in a 403(b) don't face taxes until withdrawal, which reduces your taxable income. However, 403(b) plans may also offer Roth accounts. Roth accounts differ from Traditional plans in that Roth funds are taxed before contribution. As a result, the funds grow tax-free (including earnings) with no tax payments required when the money is withdrawn and distributed.
Understanding Your 403(b) Plan
The 403(b) and 401(k) share the same limits on yearly contributions. The contribution limit for the 2024 tax year is $23,000. Also, like the 401(k), the 403(b) plan offers catch-up contributions for anyone 50 years of age or older.
Catch-up contributions are $7,500, meaning that if you are 50 or older, you can contribute an additional $7,500 for a total of $30,500 for 2024. The sum of employee and employer contributions is limited to $69,000 (for 2024) or 100% of the employee's yearly salary, whichever one is less. In addition, if your employer offers a 401(k) and a 403(b), you may contribute to both. Still, the total must be no more than the annual contribution limit.
Like any retirement plan, there are clear advantages and disadvantages to the 403(b) plan:
Advantages:
- Tax advantages. The 403(b) plan has the same tax advantages as a 401(k) and IRA. Suppose you choose a 403(b). You can reap the benefits of lower income tax and pay taxes on your funds when you distribute them. If you choose a Roth 403(b), you can pay taxes with each contribution and enjoy tax-free growth and distribution.
- Employer matching. Employers who offer 403(b) plans may also match a portion of employees' contributions to the plan. Matching contributions can be a massive advantage of the 403(b) plan. Employer matching allows you to save much more and faster towards your retirement.
- High contribution limits. 403(b) account contribution limits are the same as 401(k) contribution limits. 403(b) contribution limits are significantly higher than IRA contribution limits. Yet the 403(b) lets you split your contribution between a 401(k)-similar 403(b) and a Roth 403(b), allowing you to reap the benefits of high contribution limits and the benefits of having both a 403(k) plan and a Roth 403(b).
- Additional catch-up contributions. In addition to the regular catch-up contributions for people 50 years and older, 403(b) plans allow employees working for the same employer for at least 15 years to contribute an additional $3,000.
- Shorter vesting periods. Vesting schedules determine when the matched funds are available for you to use from your employer. In addition, a vesting schedule helps with employee retention, so they do not walk away from an established retirement plan. 403(b) plans offer shorter vesting schedules than 401(k)s, and some vesting may even be immediate.
Disadvantages:
- Limited investment choices. Investment options are limited to those chosen by the employer; 403(b)s have fewer options than 401(k)s and IRAs.
- High fees. Some 403(b)s have high administrative costs that may cut your profits. Do some research on the 403(b) plan available to see the fees.
- Early withdrawal penalty. Like 401(k)s and IRAs, 403(b)s penalize you for an early withdrawal fee of 10% before 59 ½.
Maintaining Your 403(b) Plan
If you are an employer providing a 403(b) plan, here is how you maintain and operate it:
- Follow the terms of the plan.
- Deposit employee contributions on time.
- Reporting and participant disclosure - Some 403(b) plans are subject to 5500 filing requirements.
- Conduct periodic reviews.
- Update the plan with any changes in the law.
- Conduct annual nondiscrimination testing.
Takeaway
Like any retirement plan, if you are eligible for a 403(b), you should decide whether it is right for you. If the program has low administrative costs and employer matching, it may significantly increase your retirement funds over the years. However, if the plan has limited investment options and high fees, you may be better off without it.