Retirement plans come in many different flavors and varieties. Each offers some unique advantages, while most also have drawbacks.
Your employer often plays a prominent role in which plans might be available to you to use for retirement savings. If you are a teacher, school administrator, government employee, doctor, or nurse, you might have access to a 403(b) plan.
So, what is a 403(b), and how do they work? We will explain all 403(b) details, including how they work, contribution limits, advantages, and disadvantages. Keep reading to learn all the ins and outs of 403(b) plans.
What Is A 403(b) Retirement Plan?
A 403(b) plan is a tax-deferred retirement savings plan that allows employee and employer contributions. Investments in these accounts grow tax-free until withdrawals are made at retirement age.
- These plans are typically available to public school workers and employees of non-profit or tax-exempt organizations.
- They operate much like a 401(k), which is generally offered to employees in the private sector.
- The employer may match employee contributions up to the annual contribution limit.
- Most 403(b) plans are not subject to ERISA and are not considered qualified retirement plans
- 403(b) plans are available in both standard and Roth varieties.
With standard 403(b), employees make elective contributions on a pre-tax basis, and employer contributions are also made on a tax-deferred basis. Upon reaching retirement age, the plan participant must pay income taxes on qualified distributions.
With a Roth 403(b), contributions are made after tax. The IRS allows these investments to grow tax-free until the participant reaches retirement age.
Early withdrawals before age 59 1/2 are still subject to a penalty in most cases.
KEY TAKEAWAYS
- A 403(b) retirement plan functions similarly to a 401(k) plan; however, 403(b) plans are generally reserved for public school workers and employees of non-profit or tax-exempt organizations.
- When 403(b) plans were initially created, they were known as tax-sheltered annuities. Today, investment choices are limited to annuities and some mutual funds.
- One of the significant benefits of a 403(k) is the unique catch-up contribution for employees with 15 years or more of service with their employer.
403(b) Plan Advantages
A 403(b) plan offers participants many advantages. We will discuss some of the most significant advantages here.
Tax Deferred Savings
Like 401(k) and IRAs, a 403(b) plan also offers tax-deferred savings. This means that you do not pay income taxes on your contributions today. Instead, your taxable income today is lowered, reducing the taxes you pay today.
These pre-tax contributions go into your account and can grow tax-free until you are ready to withdraw them at retirement. When you make qualified withdrawals during retirement, the amounts will be treated as ordinary income and taxed at a rate dependent upon your income.
If you choose Roth contributions, you do not get the same level of tax deferral. Instead, you pay taxes on the money today and can later withdraw it tax-free.
Matching Contributions
This is a big deal and can grow your savings even faster. Employers are allowed to contribute to the employee’s plan, and the amount they contribute varies by employer.
Some employers match an employee’s contribution dollar for dollar up to a certain percentage of their salary. This percentage usually ranges from 2% to 6%. Employees may contribute more than this amount, but the employer only matches the amount specified in the plan documentation.
If you are not taking advantage of your employer match, you are wasting money that could otherwise be going into your account.
Fewer Oversight Rules
Some 403(b) plans are non-qualified, meaning they do not qualify for ERISA protections. However, this does provide an advantage in some ways. It means that your plan is subject to fewer rules and regulations.
This makes the plan more straightforward for your employer to understand and maintain. For you, it generally means lower administrative costs. These lower costs can add up throughout your career and lead to a substantially higher balance in your account when you retire.
Shorter Vesting Period
Most employer-sponsored retirement plans require you to remain with your employer for anywhere from 6 to 36 months before you are fully vested in the retirement plan. If you leave the employer before becoming vested, you might lose some or even all the money the employer placed into your account.
However, a 403(b) plan generally has a shorter vesting period. You can sometimes become 100% vested in the plan immediately. This means that the money in the account belongs 100% to you as soon as you begin participating in the plan.
Additional Catch-Up Contributions
We all know that you want to grow your retirement account as large as possible, and catch-up contributions can help you accomplish that. Perhaps you did not contribute as much as you would have liked during your younger years, so the Internal Revenue Service allows you to contribute more than the regular annual limit during your later years to help you prepare for retirement.
If you are over 50 and have a 403(b) plan, you can make an additional catch-up contribution of $7,500 per year, like a normal 401(k) plan.
If you have more than 15 years of service with your employer, a plan provision allows for additional contributions. You can make an additional catch-up of $3,000 over the standard 401(k) contribution limit.
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403(b) Plan Disadvantage
Nearly every retirement plan also has a few drawbacks, and a 403(b) is no exception. While the benefits of these plans almost always outweigh the negatives, we will discuss some cons so that you know both sides.
Here are some of the most significant disadvantages of a 403(b) retirement plan.
Fewer Investment Choices
A 403(b) usually offers fewer investment choices than a 401(k) or an IRA. These plans’ most common investment options are fixed and variable annuity plans.
When the 403(b) plan was initially created, it was known as a tax-sheltered annuity. Today, some mutual funds are available for investment in 403(b) plans, although those choices are pretty limited.
Annuity contracts and mutual funds are the only allowable investments in a 403b plan. Stocks, bonds, and real estate are entirely off-limits.
Early Withdrawal Penalties
As with a 401(k), you can expect to pay a penalty on any early withdrawals from your 403(b). If you withdraw your funds before reaching the age of 59 1/2, then you will be subject to the additional 10% penalty.
You can avoid this penalty in a few circumstances, though. If you leave your employer after age 55, you might be able to withdraw without penalty. Similarly, if you need the money for qualified medical expenses, then the penalty might not apply.
Lack Of ERISA Protection
This can be a big one for some people. Most 403(b) plans do not qualify for protection under the Employee Retirement Income Security Act (ERISA). This means that specific nondiscrimination rules do not apply, and many reporting requirements are absent.
While this does make these plans easier and cheaper to maintain, it can also mean that they might not be offered to all employees proportionately. You should check your plan documents for your eligibility and plan details.
TIP
A 403(b) retirement plan can be a tremendous investment vehicle—generally, the advantages of these plans far outweigh any disadvantages. An employer match is one of the most significant benefits of any employer-sponsored plan.
2024 Contribution Limits For 403(b) Plan
The 2024 contribution limits for a 403(b) plan are $23,000 for the employee. This is the same as for a 401(k) plan. In addition, your employer can contribute up to an additional $46,000 to your account. This could take your total combined contribution up to $69,000 for the year.
If you are age 50 or older, you can contribute an additional $7,500 per year. As previously mentioned, a 403(b) also allows a unique catch-up contribution for those who have been with their employer for 15 years or more.
These employees can contribute an additional $3,000 up to the lifetime limit of $15,000. Whether or not the employee has reached age 50, this contribution can be made as long as they have 15 years of service with their employer.
Comparison Between 403(b) And 401(k)
When it comes to retirement planning, a 403(b) and 401(k) have many similarities. In fact, one of the biggest differences between the two is the type of plan sponsor who offers the plan.
- Employers in the private sector generally offer 401(k) plans, while 403(b) plans are usually offered to school employees and some non-profit employees.
- Both plans offer many tax benefits, providing both a Traditional and Roth version.
- Both plans typically allow rollovers, although you should check with your plan administrator or tax advisor before attempting to roll over into a Roth IRA.
- Both plans allow you to establish payroll deductions and automatically make contributions to the plan from each paycheck.
- This is one of the easiest ways to save for retirement because you never even have to consider putting money into the account!
- A 403(b) and 401(k) have the same annual contribution limits, although a 403(b) does allow you to make additional catch-up contributions above and beyond what is permitted with a 401(k) in some cases.
- Both plans require the payment of a 10% early withdrawal penalty, although a 403(b) does allow for withdrawals without the penalty if you retire from your company after age 55.
The Bottom Line
A 403(b) plan is a great way to save for retirement, and putting money away into this type of account is a great idea.
These plans offer many great tax benefits, and they even allow you to withdraw without penalty in more instances than most retirement plans.
One significant drawback is the lack of ERISA protection, but this also leads to fewer fees and administrative costs. Talk to your financial advisor today if you think a 403(b) might be right for you.
Frequently Asked Questions
In most cases, yes, a 403(b) is a good investment. These can be great tools to grow your retirement savings in a tax-advantaged plan.
While the investment options in these accounts are pretty limited, you can take advantage of an employer match and additional catch-up contributions in your later years.
The advantages of these plans typically outweigh the negatives, so most people with access to them choose to participate.
The main difference between a 401(k) and a 403(b) is the type of employer who sponsors the plan. 401(k) plans are usually offered to private sector employees, while a 403(b) is generally provided to education employees and some non-profit employees.
Many rules between the accounts are the same, such as tax benefits and contribution limits. However, a 403(b) has fewer investment options although lower administrative fees.
These plans are pretty similar. They both operate similarly to a 401(k). Both a 401(a) and 403b are usually offered by education institutions, government agencies, and non-profit organizations.
A 401(a) has a much higher annual contribution limit, which allows a participant to stash more money away in the plan than with other retirement options.
Another big difference is that employer contributions to a 401 (a) are mandatory, whether or not the employee makes any contributions.
A 457 plan is a tax-advantaged retirement savings plan offered by government agencies and some non-profits.
It comes in two flavors – 457(b) and 457(f). It operates like a 401(k) and allows employees to make tax-deferred contributions to the plan to save for retirement.
Those plans are similar regarding a 403(b) versus 457(b) plan. A 403(b) plan offers a broader array of investment choices, while a 457(b) plan allows higher catch-up contributions during your later years.
Yes, some 403(b) plans offer Roth options. The Roth option allows the participant to contribute after-tax dollars to the plan.
These investments can then grow tax-free in the plan until retirement age. Since taxes were already paid on the money before it was deposited into the account, withdrawals can be made without owing taxes on those amounts.
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