The Basics of a 403(b) Plan and All You Need to Know
If you work for a charity or other tax-exempt organization, you may have discovered that your retirement perks are lacking. You could be pausing here and wondering why the author didn’t include a 401(k) plan.
The 403(b) plan is a type of retirement savings account that may be unfamiliar to you unless you are a teacher or work for a nonprofit that is free from federal income tax. That’s because most people who dedicate their lives to helping others (such as teachers, government workers, nurses, doctors, etc.) have access to a different plan.
To make the most of your 403(b) retirement plan, we’ve included some basic information about it below, such as its perks, downsides, and contribution limits.
What Exactly Is a 403(b) Plan?
Similar to the more well-known 401(k) account, this one is normally given by private-sector employers. Public school teachers and administrators, as well as government workers, doctors, librarians, and clergy who work independently, are common users of 403b retirement plans.
In the same way that a 401(k) permits you to set a part of every salary for retirement, a 403(b) plan does it, except that your employer has the option of matching a portion of your contributions.
You can choose a tax-deferred 403(b) plan, in which case your contributions will lower your taxable income this year and you’ll pay taxes on distributions in retirement, or a tax-free Roth 403(b), in which case your contributions will be taxed this year but your funds will grow tax-free in retirement.
How Does the 403(b) Plan Work?
Basically, in a 403(b) plan, your contributions to the plan will be automatically deducted from each paycheck and invested in the accounts you designate, either as a percentage of your earnings or a fixed cash sum.
In addition, your firm may also make contributions to your account. If your firm gives a matching contribution, you should put in at least enough to get the full match as soon as you can.
403(b) vs. 401(k) Plan: What’s the Difference?
403b plan vs 401k, as you’ve undoubtedly guessed by now, are essentially the same item treated differently by the tax code. The two designs are otherwise identical; the sole distinction is in who has access to them.
Employees of for-profit firms are normally offered 401(k) plans, but those of non-profit organizations, religious institutions, public school districts, and government agencies are limited to 403(b) plans.
In terms of the contribution limit for the 403b retirement plan vs 401k, both are similar in 2021. However, long-term workers with a minimum of fifteen years of service may be eligible for a special catch-up contribution within a firm’s 403(b) plan.
In that situation, annual contributions may go as high as $3,000, with a $15,000 cap. Since this is the case, a 403(b) can eventually hold more funds than a 401(k) in your latter years of employment.
Contributions to a traditional 401(k) or retirement plan 403b are tax deductible and eligible for deferral until withdrawal. The contributions will grow tax-free until they are withdrawn. In retirement, distributions are subject to income taxation.
Roth contributions might be an option for both programs. It’s important to remember that Roth donations are treated as income and taxed the year they’re made. In a Roth IRA, your funds can grow tax-free and be withdrawn tax-free when you’re ready to retire.
403(b) Plan Contribution Limits
In 2022, the maximum annual 403b plan limits are $20,500 (up from $19,500 in 2021), or $27,000 (up from $26,000 in 2021) if you’re 50 or older. These caps are equivalent to those of a 401(k) plan.
It’s important to keep in mind that the maximum applies to your combined contributions to both your 401(k) plan and 403(b) plan in the same year if your employer offers both plans.
If you’ve been with your firm for at least fifteen years, you may be able to make a one-time added contribution of up to $3,000. In this case, you’ll want to keep careful tabs on your added contributions because the maximum sum you can put in over the course of your life is $15,000.
Naturally, if you can’t afford to give this much each year, you don’t have to. You have the freedom to determine the interest rate at which you save and to change it as frequently as you like.
In most workplace retirement plans, you get to decide how much of each paycheck goes into your retirement fund, and your employer’s contribution, if any, will be calculated as a fixed or variable percentage of your salary.
One good way to save for retirement is using a 403(b) plan. If you want your retirement savings to grow as soon as possible and bypass costly penalties, you need to pay attention to the regulations and costs.
Pros and Cons of the 403(b) Plan
A 403(b) plan comes with its own set of perks and drawbacks. The pros and cons of 403(b) plans are examined here.
Pros
The perks of putting funds into a 403(b) plan are:
- Tax advantages. There are similar tax perks for 403(b) accounts as there are for 401(k)s and IRAs. You can reduce your yearly tax burden by contributing to a regular or Roth 403(b) and paying taxes in retirement, or you can pay taxes now and get the funds tax-free when you retire.
- Limits on contributions that are quite high. Mentioned previously is the information about 403(b) contribution limits, which are on par with 401(k) limits and far higher than IRA limits.
- Employer matching. As with 401(k) plans, employers who provide 403(b) options may contribute to their workers’ accounts on their behalf.
How, when, and if an employer would match a worker’s contributions is determined on a case-by-case basis. Verify with your Human resources department for detailed facts regarding your firm’s matching program.
- Shorter vesting schedules. When your employer match becomes fully vested is determined by your vesting schedule. 403(b) plan vesting schedules are often shorter than 401(k) vesting schedules, though this varies from firm to firm.
With a 403(b) plan that features instant vesting, any contributions you make will be fully vested upon your termination of employment, allowing you to keep the full sum of any employer match.
- Additional catch-up contribution. A 403(b) plan permits members who have been employed by the same employer for at least fifteen years to contribute up to $3,000 more per year to their accounts, on top of the standard catch-up contributions allowed to persons 50 and older.
Cons
Keep in mind these disadvantages of making 403(b) contributions:
- Inadequate Investment Options. Only variable annuities were attainable in 403(b) plans until very recently. Despite the fact that this is no longer the case, the investment possibilities attainable within this sort of account are more restricted than those within a 401(k) or an individual retirement account.
- Expensive fees. The expenses linked with some 403(b) plans are higher than those linked with others; this may reduce your overall return on investment.
In order to bypass this and get the most out of your assets, you should learn as much as possible about the plan’s administrative charges and any fees related to your investments.
- Early withdrawal penalty fees. A 10% early withdrawal penalty is applied to the sum withdrawn from a tax-deferred 403(b) plan before age 59 1/2 unless the withdrawal is for a “qualifying reason,” such as a substantial medical cost. Remember that it’s also the case with 401(k)s and individual retirement accounts.
- ERISA does not always apply. Minimum rules for retirement plans, such as reporting and fiduciary standards, are established under the Employee Retirement Income Security Act (ERISA) for the benefit of workers.
But ERISA does not apply to many types of 403(b) plans. That doesn’t mean you shouldn’t put in the time and effort to figure out whether or not it’s the best place for your funds before putting any of it in.
How to Invest in a 403(b) Plan
Investment possibilities accessible in 403(b) plans are somewhat more limited than in other tax-advantaged retirement plans. You normally can choose from mutual funds and annuities. Individual stocks, ETFs, and REITs are normally not allowed to be invested in IRAs but are in 401(k)s (REITs).
However, many 403(b)s provide access to bond and stock index funds that are low-cost and come highly recommended by monetary professionals.
You should allocate your retirement savings between stock and bond funds in a manner that reflects your age, the number of years until retirement, and your comfort level with risk. Most monetary experts agree that this involves putting more funds into stock funds when you’re young and shifting to bond funds as you get older.
Investing in a 403(b) plan using target-date funds can be a fantastic way to streamline your strategy. Mutual funds called “target-date” can help you reach your retirement goal on time by rebalancing themselves as that day approaches.
A 403(b) plan also gives you the option of investing in an annuity, either partially or entirely. Annuities can be complex monetary products with hefty fees and lower-than-market returns, so check with a monetary professional before subscribing to one.
If your 403(b) plan doesn’t offer the alternatives you want, you can still use an individual retirement account (IRA) to enhance your portfolio. Before putting funds into an IRA, though, you should consider whether or not your employer offers a 403(b) match.
Is the 403(b) Plan Worth Investing In?
It’s important to spread out the risk in your retirement portfolio, which should include your 403(b). A more colloquial way of stating “don’t put all your eggs in one basket”.
Where do you even begin? Distribute your 403(b) plan investments uniformly throughout four mutual fund categories: growth, growth and income, aggressive growth, and international. It’s still worth it to invest enough to earn the employer match (remember, it’s free funds) even if the funds you’re considering aren’t particularly attractive.
Mutual funds with a track record of consistent returns might help you achieve your monetary goals. Even if there aren’t quite as many funds attainable in your firm’s 403(b) plan, you should make the most of the ones you do have.
Final Thoughts
The 403(b) plan is a tax-deferred retirement savings option that may be attainable to you if you are employed at a public school, a nonprofit, or another entity that is exempt from federal income tax.
A 403(b) plan, so-called after the provision of the tax code that defines it. It is a specialized form of a worker retirement plan that shares some features with common types of retirement plans like 401(k)s and IRAs but has some important distinctions of its own.
Taxes can be deferred on the sum you contribute to your 403(b) plan until you withdraw the funds. Unlike individual retirement accounts (IRAs), 403(b) plans normally offer fewer investment options to participants.
Investing is no exception; there are optimal times and scenarios for it. Once you’ve paid off all your debts (with the exception of your mortgage), and have an emergency fund established with six months’ worth of living expenses, then you can start contributing to your 403(b).
You should put off investing for the time being if you have ongoing debt payments or a small emergency fund. Why? Debt prevents you from investing, which is like attempting to climb a mountain while carrying a brick in your pack.
