A 403(b) is a tax-advantaged retirement plan available to many of America’s public employees, employees of universities and hospitals, religious leaders and workers at non-governmental organizations. Like a 401(k), a 403(b) comprises contributions that aren’t taxed right away. The contributions grow in a tax-deferred plan, with taxes paid upon withdrawal.
What Is a 403(b) Plan?
A 403(b) is also known as a tax-sheltered annuity (TSA). It’s like a 401(k), but for workers who aren’t with big private companies. For some employees, participation in a 403(b) is mandatory, while for others it’s optional.
Contributions to a 403(b) plan are usually taken from your wages before taxes. The money that goes into your account won’t hit ever hit your bank account (meaning you won’t be tempted to spend it). This is known as an “elective salary deferral.”
How Does It Work?
Those who enroll and make voluntary contributions can choose between annuities and mutual funds. Mutual funds mix stocks, bonds and money market holdings, and charge fees (and sometimes commission) to fund owners. Annuities come in a few different flavors: fixed, equity indexed and variable. The name of the annuity tells you how the interest rate works. Either your money will grow according to: a fixed interest rate; an equity-indexed rate tied to the overall stock market; or, in the case of a variable annuity, to the performance of individual investments.
If you participate in a 403(b), make sure to opt for a low-fee plan. Fees can eat into your retirement savings – to the tune of tens of thousands of dollars.
IRS rules for 2015 dictate that elective deferrals for an employee under age 50 can’t top $18,000. Over 50? You can make extra catch-up contributions of up to $6,000 this year.
Some lucky ducks have employers who make their own contributions to their employees’ 403(b) plans. These are known as “nonelective employer contributions.” If you contribute to a 403(b) via elective deferrals and you get employer contributions, the total can’t exceed the lesser of either $53,000 or 100% of the previous year’s wages and benefits.
403(b) accounts come with withdrawal rules, which means that they’re not a good place to stash your emergency fund. With certain exceptions, taking distributions from your 403(b) before you hit age 59 1/2 will cost you in penalties. What are those exceptions?
- If you separate from your employer, you can roll over the funds in your 403(b).
- If you die, your beneficiary can access your contributions.
- If you encounter financial hardship, you may be able to make a withdrawal (in this case, you may only access elective deferrals taken from your pay, not contributions made by your employer).
- If you are in the reserves and get called up, you may be eligible for what’s called a qualified reservist distribution.
- If you become disabled you can make a withdrawal.
403(b) Contribution Limits
For 2018, IRS contribution limits on 403(b) contributions are as follows:
- For an employee’s elective salary deferrals, the limit is $18,500.
- For total contributions, including salary deferrals and employer matching, the limit is the lesser of either $55,000 or 100% of employee compensation.
- Employees age 50 or over can make catch-up contributions of up to $6,000 on top of the regular limit.
403(b) vs. 401(k)
What’s the difference between a 403(b) and 401(k), you ask? Well, the two types of plans are offered by different kinds of employers. Employees of some private companies have 401(k)s, while employees of some tax-exempt non-profit organizations (like schools, hospitals or churches) have 403(b)s. For the employer, the 403(b) is less burdensome to administrate.
The Roth 403(b)
A Roth 403(b) has similar attributes to the Roth IRA. You fund it with after-tax dollars, and you don’t pay taxes on the money that you withdraw in retirement. Not everyone who has the option to contribute to a 403(b) has the option to choose a Roth 403(b). If you do have the choice between a regular and a Roth 403(b), how do you choose?
As with the IRA vs. Roth IRA debate, it’s a question of your tax bracket. If you think your tax bracket is higher now than it will be in retirement, it pays to save for retirement with pre-tax dollars. That means taking advantage of a regular 403(b). By doing so, you’re reducing your taxable income, which means you may owe less to Uncle Sam this year.
If, on the other hand, you think your income and tax bracket will be higher in retirement, you should probably go for a Roth 403(b). You’ll reduce the tax burden you’ll face in your post-work years.
Roth 403(b) vs. Roth IRA
What about the choice between funding a Roth 403(b) and a Roth IRA? If they both use after-tax contributions, what’s the difference? Well, Roth 403(b)s have higher contribution limits than Roth IRAs ($18,500 vs. $5,500), so if you’re a savvy saver you may be better off with a Roth 403(b). Plus, people with high incomes aren’t eligible to contribute to Roth IRAs.
On the other hand, if you decide to open a Roth IRA instead of a 403(b), you won’t be limited to the providers available through your employer. You may find a Roth IRA option on the open market that has lower fees than any of the Roth 403(b)s you have to choose from. In that case, you may want to go with the Roth IRA if it meets your savings needs.
The ability to contribute income to a 403(b) is a valuable employee benefit. The trick is a) choosing an amount for your elective deferrals that will help you save enough for retirement and b) choosing a low-fee vehicle for your contributions. Happy saving!
Tips for Getting Retirement Ready
- Figure out how much you’ll need to save in order to retire comfortably. An easy way to get ahead on saving for retirement is by taking advantage of employer 401(k) matching.
- Work with a financial advisor. According to industry experts, people who work with a financial advisor are twice as likely to be on track to meet their retirement goals. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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