Retirement plans come in many different flavors and varieties. Each offers some unique advantages, while most also come with a few drawbacks. Your employer often plays a large 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, then you might have access to a 403b plan. So, what is a 403b and how do they work? We will explain all the details of a 403b including how they work, contribution limits, advantages, and disadvantages. Keep reading to learn all the ins and outs of 403b plans.
What Is A 403(b) Retirement Plan?
A 403(b) plan is a tax-deferred retirement savings plan that allows both employee and employer contributions. The investments in these accounts are allowed to grow tax-free until withdrawals are made at retirement age. These plans are typically available to public school workers and employees of non-profit organizations or tax-exempt organizations. They operate much like a 401(k) which is typically offered to employees in the private sector. Employee contributions may be matched by the employer up to the annual contribution limit.
Most 403(b) plans are not subject to ERISA; therefore, they are not considered qualified retirement plans. 403(b) plans are available in both standard and Roth varieties. In a standard 403(b), employees make elective contributions on a pre-tax basis. 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 on an after-tax basis. The IRS still 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.
403(b) Plan Advantages
A 403(b) plan offers participants many advantages. We will discuss some of the biggest advantages here.
Tax Deferred Savings
Similar to a 401(k) and IRA, 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, hence placing you into a lower tax bracket. These pre-tax contributions go into your account, and they 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, then you do not get the same level of tax deferral. Instead, you pay taxes on the money today and can later withdraw the money tax-free.
This is a big deal and can lead to your savings growing even faster. Employers are allowed to contribute to the employee’s plan, and the amount they contribute varies by employer. Some employers choose to match an employee’s contribution dollar for dollar up to a certain percentage of their salary. This percentage usually ranges anywhere from 2% – 6%. Employees may contribute over this amount, but the employer only matches the amount specified in the plan documentation. If you are not taking advantage of your employer match, then you are leaving money on the table that could otherwise be going into your account.
Fewer Oversight Rules
Some 403(b) plans are non-qualified, meaning that they do not qualify for ERISA protections. This does provide an advantage in some ways though. It means that your plan is subject to fewer rules and regulations. This makes the plan easier to understand and easier to maintain by your employer. For you, it generally means lower administrative costs. These lower costs can really add up over the course of your career and can lead to a substantially higher balance in your account when you get ready to 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. This means that if you leave the employer before becoming vested, you might lose some or even all the money that the employer placed into your account. However, a 403(b) plan generally has a much shorter vesting period. In some cases, you can 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. With a 403(b) plan, you can make an additional catch up contribution of $3,000 per year above what a typical 401(k) offers. In addition, you do not have to be over 50 to take advantage of this. As long as you have 15 years of service or more with your current employer, you can utilize the provision of the plan that allows these additional catch up contributions.
Cons Of 403(b) Plans
Nearly every retirement plan has a few drawbacks as well, and a 403(b) is no exception. While the benefits of these plans almost always outweigh the negatives, we will discuss some of the cons of these plans so that you are aware of both sides of the coin. Here are some of the biggest disadvantages of a 403b retirement plan.
Fewer Investment Choices
A 403(b) usually offers fewer investment choices than a typical 401(k) or an IRA. The most common investment options within these plans are fixed and variable annuity plans. In fact, when the 403(b) plan was originally created, it was known as a tax-sheltered annuity. Today, some mutual funds are available for investment in 403b plans, although those choices are fairly limited. Annuity contracts and mutual funds are the only allowable investments within a 403b plan. Other common investments like stocks, bonds, or real estate are completely off limits in a 403b plan.
Early Withdrawal Penalties
As with a 401(k), you can expect to pay a penalty on any early withdrawals that you make from your 403b. 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, then you might be able to make withdrawals without the 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. This means that certain nondiscrimination rules do not apply and many reporting requirements are not present. While this does make these plans easier and cheaper to maintain, it can also mean that the plans might not be offered to all employees on a proportionate basis. You should check your plan documents for your eligibility and plan details.
2021 Contribution Limits For 403(b) Plan
The 2021 contribution limits for a 403(b) plan are $19,500 for the employee. This is the same as for a 401(k) plan. In addition, your employer can contribute up to an additional $38,500 into your account. This could take your total combined contribution up to $58,000 for the year. If you are age 50 or older, you can contribute an additional $6,500 per year. As previously mentioned, a 403(b) also allows a special catch up contribution for those who have been with their employer for 15 years or more. These employees are allowed to contribute an additional $3,000 up to the lifetime limit of $15,000. This contribution can be made whether or not the employee has reached age 50 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. A 401(k) is generally offered by employers in the private sector while a 403(b) is usually offered to school employees and some non-profit employees.
Both types of plans offer many tax benefits, and both plans offer 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 think about putting money into the account!
A 403b and 401k have the same annual contribution limits, although a 403b does allow you to make additional catch up contributions above and beyond what is allowed with a 401k in some cases. Both plans require the payment of a 10% early withdrawal penalty, although a 403b 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 make withdrawals without a penalty in more instances than most retirement plans. One of the major drawbacks is the lack of ERISA protection, but this also leads to fewer fees and administrative costs. If you think that a 403b might be right for you, then you should talk to your financial advisor today.
Frequently Asked Questions
Is a 403b a good investment?
In most cases, yes, a 403b 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 fairly 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 who have access to these plans choose to participate in them.
What is the difference between a 401k and a 403b retirement plan?
The main difference between a 401k and a 403b is the type of employer who sponsors the plan. 401k plans are usually offered to private sector employees while a 403b is generally offered to education employees and some non-profit employees. Many rules between the accounts are the same like tax benefits and contribution limits. However, a 403b has more limited investment options although lower administrative fees.
What is the difference between a 401a and 403b?
These plans are fairly similar. They both operate similarly to a 401(k). Both a 401a and 403b are usually offered by education institutions, government agencies, and non-profit organizations. A 401a has a much higher annual contribution limit that allows a participant to stash more money away in the plan than with other retirement options. The other big difference is that employer contributions to a 401a are mandatory whether or not the employee makes any contributions.
What is a 457 plan?
A 457 plan is a tax-advantaged retirement savings plan offered by government agencies and some non-profits. It comes in two flavors – 457b and 457f. It operates very much like a 401k and allows employees to make tax-deferred contributions into the plan to save for retirement. When it comes to a 403b versus 457b plan, those plans are very similar. A 403b plan offers a wider array of investment choices, while a 457b plan allows higher catch up contributions during your later years.
Are there any Roth options with a 403b plan?
Yes, some 403b plans offer Roth options. The Roth option allows the participant to contribute after-tax dollars into the plan. These investments can then grow tax-free in the plan until retirement age. Since taxes were already paid on the money before being deposited into the account, withdrawals can be taken without owing taxes on those amounts.