403(b) Plan: A Retirement Plan for Non-Profit Organizations
It’s possible that you’ve never heard of the 403(b) retirement plan if you haven’t worked in education or for a nonprofit organization before.
A 403(b), which gets its name from the provision of the tax code that explains it, is a specialized form of the retirement savings plan known as a 401(k). It is comparable to a 401(k) in many respects, but there are a few significant distinctions between the two types of plans.
To assist you in getting the most out of this account, we have provided a concise summary of the 403(b) retirement plans, along with a discussion of their benefits, drawbacks, and contribution restrictions.
What is a 403(b) Plan?
Employees of organizations that do not make a profit, such as hospitals and churches, as well as some workers in the public sector, such as teachers and librarians, are eligible to participate in a tax-advantaged retirement plan known as a 403(b).
Your retirement funds can grow tax-efficiently with a 403(b), just like they can with any other type of employer-sponsored retirement plan. Because of this, the assets you purchase and sell within your account are exempt from taxes on capital gains, which enables you to more easily accumulate savings for your golden years.
Your 403(b) account will have funds taken out of your paycheck each pay period to cover the contributions you make. Contributions to a typical 403(b) plan are taken out of an employee’s paycheck before taxes are withheld, which results in a reduction of that employee’s overall tax liability.
You will be responsible for paying income taxes on any funds that you withdraw from your retirement account once you reach the age of retirement. You have the option of putting funds into your Roth 403(b) account that has already been taxed if your company provides that choice.
If your employer does not provide that option, you must put funds into your account. In the future, when you take funds out of the account, you won’t have to pay any taxes on the funds, not even on the investment earnings, and this is true regardless of how much your funds have grown.
How Does a 403(b) Plan Work?
You will have the opportunity to select the sum of funds that you wish to deposit into the plan, which can be either a predetermined cash sum or a portion of your annual salary. The sum that you select will then be deducted from your paycheck and deposited in the many alternatives that are available to you.
Plus, as an added perk, businesses are able to make contributions to their employees’ accounts. If your company offers a matching contribution, you should put in at least as much as they are willing to as soon as you are in a position to do so. People, this fund is completely free!
Now, a word of warning with regard to 403(b) plans: these plans often offer fewer options than the majority of 401(k) plans, and they could be filled with insurance goods such as annuities that have low returns, exorbitant fees, and surrender fines. You’re better off avoiding those and investing in solid growth stock mutual funds.
403(b) vs 401(k): What’s the Difference?
You’ve probably worked out by this point that a 401(k) and a 403(b) are very much the same things; the only difference is that they come from separate sections of the tax code. The only significant distinction between these two schemes is the participants who have access to each of them.
401(k) plans are made available to workers in the vast majority of privately owned companies, while 403(b) plans are restricted to workers in the nonprofit, religious, school district, and government sectors.
In addition to that, there are a few more subtle distinctions, some of which we’ve already covered. For instance, most 401(k) plans and 403(b) plans offer participants a wider variety of opportunities for investment.
On the other hand, 403(b) plans typically come with more expedited vesting timelines, which means that you won’t have to wait nearly as long before you can claim ownership of the employer match. Employees who have been with the company for at least 15 years are eligible to have a larger portion of their salary invested for retirement purposes.
403(b) Plan: Pros and Cons
The merits and downsides of 403(b) plans are discussed in more detail below.
Investing in a 403(b) plan comes with a number of perks, including the following:
Tax advantages – In general, 403(b) accounts offer the same favorable tax treatment as 401(k) plans and individual retirement accounts (IRAs).
If you settle taxes on your commitments and choose either a regular or Roth 403(b), you can reduce your tax liability for this year in return for paying taxes on distributions when you retire, or you can settle taxes on your commitments and enjoy tax-free withdrawals when you retire.
High caps on the sum of contributions -The maximum sums that can be contributed to a 403(b) account are comparable to those that can be contributed to a 401(k), but they are significantly higher than those that can be contributed to an IRA.
Employment compatibility – Employers who provide 403(b) plans have the option of matching some or all of the personal contributions made by their employees, much as employers who provide 401(k) plans might do.
Regarding the manner in which, the timing of, and the decision to match employee contributions, every company has its own set of guidelines and policies. If you want precise specifics regarding the matching program your employer offers, you should talk to the HR department.
Reduced vesting periods – The vesting timeline for your retirement account will tell you when your funds, including any employer contributions, are fully yours to retain. Vesting timelines for 401(k) plans are often longer than those for 403(b) plans, however, the length of these schedules can vary from business to firm.
There are some 403(b) plans that may provide instant vesting, which means that you are entitled to keep all of the employer-matched funds that you have made, regardless of when you leave that work.
Additional late contributions – Participants in a 403(b) plan who have been employed by the same company for at least 15 years are eligible to make an additional $3,000 in catch-up contributions to their accounts each year. This is in addition to the usual catch-up contributions that are made available to persons aged 50 and older.
When making contributions to a 403(b) account, it is important to keep in mind the following potential downsides:
Few available investing options – Only variable annuities were available for investment in 403(b) plans up until quite recently. Although this is no longer the scenario, the investment possibilities available through this sort of account are more constrained than those provided by a 401(k) or an IRA.
Costly charges – Although this is not the case with all 403(b) plans, some of them have more expensive fees that can reduce the sum of funds you make.
In order to avoid this, you should do a little digging into the plan’s operational charges as well as any fees that are related to your investments. Then, in order to optimize your profits, you should aim to keep these costs as low as possible.
There are fees associated with early withdrawals – If you take funds out of your tax-deferred 403(b) account before you turn 59 and a half, you will be subject to a 10% premature withdrawal penalty on top of the taxes that you owe. However, this penalty can be avoided if you have a qualified reason, such as a significant medical bill. Please be aware that this is also the case with 401(k)s and IRAs.
ERISA doesn’t always apply to things – Employees are safeguarded by the Employee Retirement Income Security Act (ERISA), which establishes minimum requirements for retirement plans, such as reporting and fiduciary requirements. However, ERISA does not apply to the majority of 403(b) plans.
Even though this does not imply that the plans are flawed, you should conduct an additional study to see whether or not this is the best place for your funds to be invested before you start making contributions.
What are the Contribution Limits of the 403(b) Plan?
The maximum sum an employee can contribute to their 403(b) plan in 2023 is set at $22,500. Employees who are 50 years of age or older are eligible to make catch-up payments of up to an extra $7,500, bringing their maximum annual contribution to $30,000 in 2023.
Those who have been with their employer for at least 15 years are eligible to make annual catch-up contributions of $3,000, up to a maximum of $15,000. This is just one of the many ways in which 403(b) can help long-term employees of eligible companies.
In theory, someone aged 50 or older could put away $33,000 over the course of five years if they took advantage of these in addition to the federal catch-up contribution.
Employers have the option of funding their employees’ 403(b) accounts with either matching or non-matching contributions, but this practice is somewhat less frequent than it is with 401(k).
Contributions from employees and employers together can reach a maximum of $66,000 in 2023, or the sum equal to one hundred percent of the participant’s most recent annual wage, whichever is lower.
Is the 403(b) Plan a Good Investment?
Individuals who are employed by nonprofit organizations might benefit greatly from participating in a 403(b) plan throughout their retirement years.
It functions in a manner analogous to that of a 401(k) plan and offers a multitude of advantages, including the potential to make tax-deductible as well as tax-free contributions, the availability of a Roth IRA, a matching contribution from the employer, and a number of catch-up contribution restrictions.
In order to grow wealth and prepare for retirement, you can take advantage of tax breaks by investing in a 403(b). However, you may find that a separate retirement account, such as an IRA, better suits your investment needs than your 403(b).
For those in the education or charity sectors who are planning for their retirement, a 403(b) can present a wealth of options. Think about whether a traditional 403(b) or a Roth 403(b) is better for you, and consult with your plan administrator before making any investment decisions.
You can also get advice on your 403(b) choices from the office that handles your benefits. If you need assistance learning how to invest your funds, particularly for your retirement, you may wish to consult with a fiduciary financial advisor.
The right mix of short-term and long-term investments, according to your specific situation, is something a financial advisor can help you with.