403(b) is a retirement plan for employees of tax-exempt organizations, as per the IRS. It includes public schools, higher education institutions, churches, and organizations that operate on charity.
It is also sometimes referred to as a 403(b) savings plan because of the nature of the account. It is meant to save you money for your retirement. In some organizations, 403(b) is also called 403(b) pension plan. However, both are the same. The use of pension is only partially accurate. Although it provides money like a retirement pension, the payout is not specific. It depends on the amount you have contributed during work and often varies significantly among individuals.
403(b) As A Supplemental Retirement Plan
Some employers provide 403(b) as an optional savings account for employees to benefit from in addition to their other plans. It supplements that account and, therefore, is referred to as a supplemental 403(b) account. What differentiates it is the voluntary participation.
Specific rules should be checked if you opt for 403(b) as a supplemental plan. For example, if a person participates in 401(k) and 403(b), the maximum contribution limit remains unchanged. However, additional documents may be required to set up a 403(b) plan.
Types of 403(b)
There are two major types of 403(b), which are as follows:
Tax Deferred Annuity 403(b)
It is also called the 403(b) TDA or the 403(b) annuity plan. These accounts use tax-deferred income and grow over time without paying taxes. Upon retirement, withdrawal starts, which is called distribution, and taxes on 403(b) distributions are applied as per tax bracket.
Roth 403(b)
Roth 403(b) differs from tax-deferred 403(b) because the contributions are made using taxed income, and the account has taxed money.
403(b)9
This 403(b) account type is designed for churches and related organizations.
403(b)7 Plans
This type of 403(b) account invests in mutual funds and is overseen by a financial institution.
What Is A 403 B Matching Plan
A 403(b) plan in which the employer contributes a matching amount per the employee’s contribution is referred to as a 403(b) matching plan. Per the IRS, this plan has a maximum limit of $66,000 as of 2024. The contributions are tied to working with the employer, and specific details vary for each employer. Who can participate in the 403(b) plan?
How Does A 403(b) Retirement Plan Work
As discussed earlier, the 403(b) plan only applies to employees of specific public-sector educational organizations, churches, and related charities-based organizations. It is advantageous because it offers certain tax benefits that other plans don’t. However, there are different rules one should consider before opting into it.
The funds accumulated in 403(b) accounts are used as investments of various types and thus grow. The profits are reinvested, and wealth is accumulated over years without tax deduction.
IRS controls 403(b) legislation and enforces retirement plan rules. Managers and board members of fiduciaries make investments on behalf of participants.
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To completely understand the 403(b) plan, here are important points:
Eligibility
To be eligible for 403(b), you have to be one of the following:
- Public Schools and Universities: Still eligible.
- Government Employees: Yes, they can participate.
- Medical Professionals: Eligible.
- Ministers (Self-Employed): Included.
- Chaplains: Also eligible.
- Church Employees: Yes, they qualify.
Difference Between Tax Deferred and Roth 403(b)
Both plans are the same, with a slight taxation difference. In Roth accounts, contributions are made using taxed money, and withdrawals are not taxed. On the other hand, contributions in a tax-deferred plan (also called a TDA 403 plan) are made using before-tax income. Read more on the 403(b) and Roth 403(b) differences.
Contributions
The minimum contribution limit for employees is $200, and the maximum is $23,000. The annual limit for employer and employee contributions is $69,000. These limits have changed over the years. You should keep yourself updated regarding the latest developments from the IRS regarding 403(b) accounts.
Withdrawal Rules
To withdraw from 403(b) account, the account holder must be 59.5 years old or retired at 55. There are other options for withdrawing early, but sometimes a 10% penalty is imposed. In the case of Roth 403(b), which is contributed using taxed income, the penalty is limited to the withdrawal of profits on contributions only. Read IRS rules for 403(b) withdrawal.
History of 403(b) Plans
The 403(b) plan was rolled out in 1953 and has changed dramatically over the years. Specifically, the regulations regarding withdrawal and penalties were introduced to achieve maximum benefits for account holders and financial institutions.
The significant changes in the history of 403(b) concern withdrawals, distributions, and contribution limits. Rules to accommodate rollovers to and from other retirement accounts and flexibility in retaining savings accounts were also changed.
Pros of 403(b)
A 403(b) plan is a retirement account available to individuals working in public education and specific tax-exempt organizations.
The significant advantages are as follows:
- Reduced taxes
- Higher contribution compared to 401K
- Employer matching Contributions
- Shorter time for ownership of account (vesting)
- Catch up contributions
- Rollover flexibility (in case of leaving job)
- Varying investment choices
- You can withdraw at 55 years without penalty (as per rule 55)
- Early withdrawal (also called 403b loan) without penalty is possible for financial hardship (higher taxes may apply).
- Disability and death allow withdrawal without penalty (higher taxes may apply).
Cons of 403(b)
As you know, 403(b) has many benefits and is therefore seen as a valuable investment asset among the masses. However, certain drawbacks may apply to certain individuals only. It is important to consider these, too, before taking on the plan.
We always recommend consulting a financial advisor for a detailed analysis of your financial aspects and devise a future strategy based on family, health, and economic outlook. Nevertheless, let’s explore the disadvantages of 403(b) plans.
- Withdrawal restrictions
- Penalty on early withdrawal (up to 10%)
- Taxes on early withdrawal (for tax-deferred accounts only)
- Fewer investment options sometimes
- Higher fees that may churn your profits and returns
- Complex rules and regulations regarding contributions
- Yearly changes in rules may complicate your planning
- Higher cost and administrative fees compared to other plans.
- In some cases, transferring accounts can be complicated when changing jobs.
Conclusion
In summary, a 403(b) plan is a tax-advantaged retirement account primarily offered to employees of nonprofit organizations, educational institutions, and certain religious groups. The plan is suitable for individuals planning to retain investment until age 55 (at least). Moreover, it is recommended to ask a financial advisor for advice based on current and future circumstances.
