Unless you work in education or for a nonprofit, you might not have heard much about the 403(b). It’s basically a retirement savings plan, just like a 401(k), but it comes with some unique features.
To put it simply, a 403(b) is named after a specific section in the tax code, and it’s designed to help you save for your retirement. Now, let’s take a quick look at 403(b) retirement plans, their advantages, disadvantages, and how much you can contribute to them. This should help you understand this account better.
What is a 403(b) plan?
A 403(b) plan is a retirement account designed for folks who work in public education or for specific tax-exempt organizations, like nonprofits. It’s quite similar to the more commonly heard of 401(k) account, which private sector employers often offer. People who commonly use 403(b) plans include government employees, healthcare professionals, librarians, self-employed ministers, and school staff such as teachers and administrators.
Much like a 401(k), a 403(b) allows you to set aside a part of your earnings for retirement. If your employer decides to, they might even match some of your contributions. There are two types of 403(b) plans: one is tax-deferred, meaning you reduce your taxable income this year by contributing and pay taxes on withdrawals in retirement, and the other is a Roth 403(b), where you pay taxes on your contributions now, but your money grows tax-free for the future.
Types of 403(b) Plans
In the world of 403(b) plans, there are generally two main types: the traditional and the Roth. It’s important to note that not all employers offer the Roth option.
Here’s how they work:
Traditional 403(b): With this type, you can have some money taken out of your paycheck before taxes are calculated. It’s like putting money in a retirement piggy bank. This not only helps you save for the future but also lowers your overall taxable income for the year. You’ll pay taxes on this money when you eventually take it out in retirement.
Roth 403(b): This one works a bit differently. You put after-tax money into your retirement account, so there’s no immediate tax benefit. However, the good news is that when you withdraw this money, along with any earnings it has made, you won’t owe any more taxes. It’s like paying your taxes upfront so that your future self gets to enjoy tax-free withdrawals.
So, in a nutshell, traditional 403(b) gives you a tax break now but taxes later, while Roth 403(b) skips the tax break now but lets you enjoy tax-free withdrawals in the future.
Pros and cons of a 403(b)
Let’s take a more in-depth look at the pros and cons of a 403(b) plan:
Benefits of a 403(b) plan
Let’s take a closer look at the benefits of contributing to a 403(b) account:
Tax Advantages: Much like 401(k)s and IRAs, 403(b) accounts offer some significant tax perks. Depending on whether you choose a traditional or Roth 403(b), you can either reduce your current tax bill and pay taxes on withdrawals in retirement, or enjoy tax-free retirement withdrawals if you pay taxes on your contributions upfront.
Generous Contribution Limits: When it comes to how much you can put into your 403(b), the limits are quite high. They’re on par with 401(k) contribution limits and far exceed those of IRAs.
Employer Matching: Some employers who offer 403(b) plans might also match a portion of what you contribute, similar to how 401(k) plans work. The specifics of their matching program, such as when and how much they contribute, can vary, so it’s a good idea to check with your HR department for the details.
Shorter vesting schedules: The time it takes for you to fully own the employer-matched funds, known as vesting, tends to be shorter in 403(b) plans compared to 401(k) plans. In some cases, you might even have immediate vesting, meaning all employer contributions are yours to keep, no matter when you leave your job.
Additional Catch-Up Contributions: If you’re 50 or older, you can make catch-up contributions in most retirement accounts. But with 403(b)s, if you’ve been with the same employer for at least 15 years, you can contribute up to an extra $3,000 per year to your account on top of the standard catch-up limit.
Drawbacks of a 403(b) plan
Here are some things to keep in mind when contributing to a 403(b) account:
Limited Investment Choices: In the past, 403(b)s mainly offered variable annuities as investment options. While this has changed, 403(b) accounts still tend to have fewer investment choices compared to 401(k)s or IRAs.
Possibly High Fees: Some 403(b) plans may come with higher fees that can eat into your earnings, although not all of them do. To make sure you’re getting the most out of your account, check the plan’s administrative costs and investment fees. Aim to keep these expenses as low as possible.
Penalties for Early Withdrawals: If you take money out of your tax-deferred 403(b) before you reach age 59 1/2, you’ll face a 10% early withdrawal penalty, in addition to regular taxes. There are exceptions, like if you have a significant medical expense. It’s worth noting that this penalty also applies to IRAs and 401(k)s.
Not Always Covered by ERISA: The Employee Retirement Income Security Act (ERISA) sets certain standards for retirement plans to protect employees. However, many 403(b) plans are not subject to ERISA. This doesn’t necessarily make them bad options, but it means you should do some extra research to decide if a 403(b) is the right place for your money before you start contributing.
403(b) contribution limits
You can put up to $22,500 into your 403(b) in 2023 ($20,500 in 2022). If you’re 50 or older, you can contribute $30,000 per year ($27,000 in 2022). These limits are the same as what you can put into a 401(k). But here’s the thing: if your employer offers both a 401(k) and a 403(b) in the same year, these limits apply to the total you contribute to both accounts combined.
Now, if you’ve been with your employer for at least 15 years, you might be able to add an extra $3,000 on top of the standard limits in one year. However, there’s a lifetime cap of $15,000 for this, so be sure to keep track of how much extra you’re putting in.
Remember, you don’t have to max out these limits if it’s not doable for you. You get to decide how much you save, and you can change it whenever you need to. Typically, you choose a percentage of your paycheck to go toward your retirement. And if your employer matches your contributions, they’ll do it based on a percentage of your yearly income.
A 403(b) is a great way to save for retirement, but it’s important to understand the rules and fees so you can grow your retirement fund efficiently and avoid any unnecessary penalties.
