A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan offered by public schools and certain tax-exempt organizations. This plan allows employees to contribute some of their salary to this plan, pre-tax, up to a certain limit. It’s named after its section in the IRS code and is similar to its more well-known counterpart, the 401(k).
Understanding the 403(b) plan is crucial for those who are eligible for it, as it can be a significant part of their retirement strategy. This glossary entry will delve into the details of the 403(b) plan, its benefits, limitations, and how it compares to other retirement plans.
Understanding the 403(b) Plan
The 403(b) plan is a defined contribution plan where an employee can defer a portion of his or her salary into this plan. The contributions are made pre-tax, which means they are not included in the employee’s taxable income for the year. This reduces the employee’s taxable income, potentially pushing them into a lower tax bracket.
Once the money is in the 403(b) plan, it grows tax-deferred until it is withdrawn. This means that any dividends, interest, or capital gains generated by the investments within the plan are not subject to tax until they are withdrawn. This allows the money to grow more quickly than it would in a taxable account.
Eligibility for the 403(b) Plan
Not everyone is eligible for a 403(b) plan. These plans are only available to employees of tax-exempt organizations that are 501(c)(3) organizations, public school employees, certain ministers, and employees of cooperative hospital service organizations. If you fall into one of these categories, you are eligible to participate in a 403(b) plan.
It’s important to note that even if you are eligible, your employer must offer a 403(b) plan in order for you to participate. Not all eligible employers offer these plans. If your employer does not offer a 403(b) plan, you may want to explore other retirement savings options, such as an IRA or a 401(k) if available.
Contributions to the 403(b) Plan
Contributions to a 403(b) plan are made pre-tax, which means they are deducted from your paycheck before taxes are taken out. This reduces your taxable income for the year, potentially lowering your tax bill. The maximum amount you can contribute to a 403(b) plan in 2021 is $19,500. If you are age 50 or older, you can make additional catch-up contributions of up to $6,500, for a total of $26,000.
Some 403(b) plans also allow for after-tax contributions, known as Roth contributions. These contributions do not reduce your taxable income for the year, but they do grow tax-free, and qualified withdrawals are tax-free. This can be a good option for those who expect to be in a higher tax bracket in retirement.
Benefits of the 403(b) Plan
There are several benefits to participating in a 403(b) plan. One of the main benefits is the tax advantage. Contributions are made pre-tax, reducing your taxable income for the year. The money then grows tax-deferred until it is withdrawn. This allows your money to grow more quickly than it would in a taxable account.
Another benefit is the potential for employer matching. Some employers will match a portion of your contributions to the 403(b) plan. This is essentially free money that can help boost your retirement savings. However, not all employers offer matching contributions, so it’s important to check with your employer to see if this is a benefit they offer.
Limitations of the 403(b) Plan
While there are many benefits to the 403(b) plan, there are also some limitations. One of the main limitations is the contribution limit. In 2021, the maximum amount you can contribute to a 403(b) plan is $19,500, or $26,000 if you are age 50 or older. This limit includes both your contributions and any employer matching contributions. If you want to save more for retirement, you will need to explore other options.
Another limitation is the early withdrawal penalty. If you withdraw money from your 403(b) plan before age 59 1/2, you will have to pay a 10% early withdrawal penalty in addition to regular income tax. There are some exceptions to this rule, such as if you become disabled or if you leave your job in or after the year you turn 55.
Comparing the 403(b) Plan to Other Retirement Plans
The 403(b) plan is similar to other defined contribution plans, such as the 401(k) and the 457(b) plan. All of these plans allow for pre-tax contributions and tax-deferred growth. However, there are some differences between these plans that can make one more attractive than the others depending on your situation.
One of the main differences is the employer match. While some 403(b) plans offer employer matching, not all do. In contrast, employer matching is more common with 401(k) plans. If your employer offers a match, this can significantly boost your retirement savings.
403(b) vs 401(k)
While the 403(b) and 401(k) plans are similar in many ways, there are some key differences. One of the main differences is who can participate. The 403(b) plan is only available to employees of certain tax-exempt organizations, while the 401(k) plan is available to any employee of a company that offers the plan.
Another difference is the investment options. 403(b) plans typically offer fewer investment options than 401(k) plans. This can limit your ability to diversify your portfolio within the plan. However, the investment options in a 403(b) plan are often lower cost than those in a 401(k) plan, which can save you money in the long run.
403(b) vs IRA
The 403(b) plan and the IRA (Individual Retirement Account) are both retirement savings vehicles, but they have some key differences. One of the main differences is the contribution limit. The maximum you can contribute to a 403(b) plan in 2021 is $19,500, or $26,000 if you are age 50 or older. In contrast, the maximum you can contribute to an IRA in 2021 is $6,000, or $7,000 if you are age 50 or older.
Another difference is the tax treatment. Contributions to a 403(b) plan are made pre-tax and grow tax-deferred. In contrast, contributions to a traditional IRA are made with pre-tax dollars and grow tax-deferred, while contributions to a Roth IRA are made with after-tax dollars and grow tax-free.
Conclusion
The 403(b) plan is a valuable retirement savings tool for those who are eligible. It offers tax advantages and the potential for employer matching, which can help boost your retirement savings. However, it also has some limitations, such as the contribution limit and the early withdrawal penalty.
It’s important to understand the details of the 403(b) plan and how it compares to other retirement plans in order to make the best decision for your retirement savings strategy. Always consult with a financial advisor or tax professional to ensure you are making the best decisions for your individual circumstances.
