403(b) are also known as tax-sheltered annuities (TSA). Aside from who they are made available to, these retirement plans act very similar to 401(k). 403(b) plans are limited to eligible employees of public schools, colleges, universities, churches, or other organizations that fall underneath IRC Section 501(c), such as a non-profit.
403(b) plans act very similar to 401(k) plans. Both consist of pre-taxed contributions that are directly from your wages, and grow tax-deferred until withdrawal or retirement. Also, there are Roth options to both accounts, where your contributions are taxed, and grow tax-free.
Who Can Contribution To 403(b) Plans?
403(b) plans serve employees of the public sector. This includes organizations that fall underneath the IRS’s 501(c)(3) rule, such as churches, charities, or non-profit organizations like the Salvation Army. Government entities that are labeled in code section 170(b)(1)(A)(ii), such as public schools, universities, or state colleges, also are able to start 403(b) plans.
It is important to know that 403(b) are employer-sponsored plans. If your employer offers a 403(b) plan, it may be required for all eligible employees to participate. The best route for clarity is to review your benefits package, or simply ask your employer for more information on their retirement plan offerings.
What Is The 403(b) Plan Contribution Limit?
The 2020 maximum annual contribution limit for 403(b) plans is $19,500, the same amount as a 401(k). The limit will change if the employee also contributes to other retirement plans, such as a SIMPLE IRA or 401(k). There is an additional $6,500 catch-up contribution made eligible for ages 50+, for a total of $26,000. Another large benefit discussed later is the plan’s 15-year rule.
403(b) plans offer four types of contributions, elective deferrals, non-elective employer contributions, after-tax contributions, and designated Roth contributions. Elective deferrals are the only type that will lower an individual’s tax bracket, the rest will include their gross income.
Employers may or may not offer 403(b) contribution match incentive in their benefit plans. The total annual amount both an employer and employee can make is $57,000 in 2020.
Benefits and Downsides of 403(b) Plans
The benefits of 403(b) plans are very similar to 401(k) plans, as well as there are traditional and Roth accounts made available. Check out some of the other 403(b) benefits.
Benefits Of 403(b) Plans
Individuals that stay with a qualified employer for more than 15 years, they are eligible for the additional contributions. The 15-year rule allows individuals to contribute an additional $3,000 for up to 5 years ($15,000 in total). Differing from the other catch-up contribution, you do not need to be 50 years or older to be eligible for the 15-year rule.
403(b) plans are tax advantaged plans. Contributions to traditional accounts consist of elective deferrals, which lower your annual gross income. Unfortunately, you will have to pay taxes once you begin withdrawals. Roth 403(b), which do not have age restrictions, are also made available. Roth contributions are after-tax dollars, and earnings grow tax-free!
Downsides Of 403(b) Plans
The immediate downside of 403(b) plans is that they are limited to only qualified organizations. Also, while it is great that taxes are deferred from traditional accounts’ contributions, you will have to pay taxes come retirement.
Investment options is a large downside of 403(b) accounts. When 403(b) plans were brought to market, annuity contracts were the only investment made available — hence the name, Tax-Sheltered Annuity (TSA). Times have changed, and mutual funds are now available, but be sure to review the expense ratios. Ideally, you would want a low-cost range of investment.
Lastly, it is common for these plans to not be insured by the Employee Retirement Income Security Act (ERISA). ERISA establishes minimum standards for retirement and health plans, but only in the private sector. If your plan is not protected by the ERISA, look into potential other plans offered by your employer, or meet with a financial advisor to discuss other potential options.
403(b) Withdrawal Rules
Retirement plans aren’t always the best place to keep rainy day funds, withdrawals come with rules and potential penalties. In any withdrawal scenario, 403(b) funds will be taxed at a federal income level. Furthermore, if you are to take early distributions, there is an additional 10% penalty tax. The best way to avoid unnecessary taxes is to begin taking distributions at 59 ½.
There are events aside from financial hardship that the IRS will allow distributions without tax penalization. This includes losing your job, disability, or dying. Again, these tax benefited accounts should be leveraged for retirement income purposes, not for trading. For those looking to trade some extra cash, look into opening a brokerage account.