What Is a 403(b) Plan?
A 403(b) plan is a saving type of tax-sheltered annuity (TSA). Employees of tax-exempt organizations are eligible for this type of plan. Employers may include these retirement savings plans in an employee’s benefits package.
Simply put, a 403(b) plan is an employer-sponsored retirement savings plan offered by public schools, nonprofits, and other tax-exempt organizations. Consider the 403(b) as a large bucket into which you put money for your future. When you retire, you withdraw money from that bucket.
The 403(b) plan, similar to the more well-known 401(k) plan, allows participants to save for retirement through payroll deductions while receiving tax benefits. The employer can also match a portion of the employee’s contribution.
Contributions to a 403(b) plan are taxed once the money is withdrawn. Your investment will grow tax-free in the same way to 401(k) plans, however investments are limited to annuities and mutual funds.
Contribution limits exist, but they are fairly generous and gradually increase yearly to keep up with inflation.
1. How Does the plan Works?
A 403(b) plan is a one of the types of workplace retirement plans. Employees can request that their employers defer a portion of their pay to these retirement accounts so that the earnings are only taxed once the money is withdrawn. Employers have the option of matching their employees’ contributions.
The 403(b) plan has the same annual contribution limits as 401(k) plans. For the tax years 2022 and 2023, the maximum contributions are $20,500 and $22,500, respectively. The plan also includes a $6,500 catch-up contribution for those 50 and older in 2022, increasing to $7,500 in 2023.
If your employer gives you both options, like 403(b) and the 401(k) plan, you can contribute to both, but your total contribution cannot exceed the annual limit ($20,500 in 2022 and $22,500 in 2023), not including any catch-up contributions.
When you’re vested in your 403(b) plan, it means you’ve been with your employer for some time. The length of time depends on your employer and the terms of your plan. With each additional year of employment, the percentage of your vesting increases. If you’re fully vested, your employer can’t take back any contributions they’ve made.
If you change jobs after you’ve vested in the plan, you can take the money with you, but you may have to roll it over into an IRA account. If you leave your job before you’ve vested, you’ll lose your employer’s contributions but keep the money you’ve put into your plan. Any contributions you make to the plan are always fully vested.
2. 403(b) Plan Types
Traditional and Roth 403(b) plans are the two most common types of 403(b) plans. Not all employers provide their employees with access to the Roth version.
2.1. Traditional 403(b)
These plans are funded with pre-tax dollars, and the money inside grows tax-deferred. That simply means you won’t pay taxes on the money now, but you will be taxed on withdrawals in retirement.
2.2. Roth 403 (b)
You contribute after-tax dollars to a Roth 403(b), so the money grows tax-free, and you don’t pay taxes on it when you withdraw it in retirement.
But keep in mind that only your contributions grow tax-free. If your company offers to match your investment, your money grows tax-free. That means you’ll have to pay taxes on the match portion of the account later.
3. Advantages of the 403(b) Plan
3.1. Tax Benefits:
403(b) accounts provide the same tax benefits as 401(k) and IRA accounts. Whether you choose a traditional or Roth 403(b), you may enjoy a lower tax bill this year in exchange for taxes on retirement distributions or tax-free withdrawals in retirement if you pay taxes on your contributions.
3.2. Fewer Admin Costs:
Certain 403(b) plans are exempt from the Employee Retirement Income Security Act’s onerous oversight requirements (ERISA). As a result, these plans typically have lower administrative costs, putting more money back into the employee’s pocket.
3.3 Matching employers:
Employers offering 403(b) plans, like those offering 401(k) plans, may offer to match some of their employees’ personal contributions. Every company has its own set of rules for how, when, and if it will match employee contributions.
4. Disadvantages of the 403(b) Plan
4.1 Tax Penalty:
Ir you withdrawn funds from a 403(b) plan before the age of 59 you are subject to a 10% tax penalty, though you may be exempt from the penalty if you are 55 or older, need to pay a qualified medical expense, or become disabled.
4.2. Higher Fees:
Some 403(b)s charge higher fees that can eat into your profits, but this isn’t always the case. To avoid this, investigate the plan’s administrative costs and any fees associated with your investments, and try to maintin these as low as possible to maximize your profits.
4.3. ERISA is not always applicable:
To protect employees, the Employee Retirement Income Security Act (ERISA) establishes minimum standards for retirement plans, including reporting and fiduciary standards. However, many 403(b) plans are exempt from ERISA. That doesn’t mean they’re bad plans, but you should do more research to determine if it’s the best place for your money before you start contributing.
Because of the additional opportunities for catch-up contributions, many employees prefer a 403(b) over a 401(k). Employees with at least 15 years of work can contribute thousands of dollars to a 403(b) plan in addition to their elective deferrals and any employer match. The same cannot be said for 401(k)s. However, 401(k)s and 403(b)s are very similar.
It is always preferable to consult an expert to determine your best retirement plan.