What is a 403(b) Plan?
If you have ever worked for a nonprofit organization, you likely have heard the term 403(b) retirement plan. While not as common as the 401(k), a 403(b) shares many of the same benefits that make it a very powerful retirement tool for those working for public schools and other tax-exempt organizations.
As noted above, 403(b) plans have much in common with the 401(k) plan, which is very common in the private sector. Participants that may have access to 403(b) include:
- Employees of public schools, state colleges, and universities
- Church employees
- Employees of tax-exempt 501(c)(3) organizations
The 403(b) plan has the same caps on annual contributions applying to 401(k) plans.
Employers can match contributions based on the specific plan details, which vary from employer to employer.
Employees may also be able to contribute to a pre-tax 403(b) and/or Roth 403(b), as both options may be available based on the plan details. A traditional 403(b) plan allows employees to have pre-tax money automatically deducted from each paycheck and deposited into their retirement account. The employee receives a tax break as these contributions lower their gross income (and income taxes owed for the year). The taxes will be due on that money only when the employee withdraws it in retirement.
A Roth 403(b) is funded with after-tax money, with no immediate tax advantage. But the employee will not owe any more taxes on that money or the profit it accrues when it is withdrawn (if they are 59 ½ and have a Roth for five years).
Pros and Cons
Being able to save for retirement automatically is a tremendous benefit of the 403(b) construct. The tax-deferred (pre-tax) or tax-free growth(Roth) nature of these savings is also a huge incentive for employees to save as much as possible – not to mention the free money an employer match may provide. Many 403(b) plans will have a shorter vesting period relative to their 401(k) cousin, which allows. This means employees will have access to the matching funds quicker should they change employers.
On the downside, withdrawing funds before age 59 ½ will likely result in a 10% early withdrawal penalty. And many 403(b) plans offer a more limited range of investment options than other retirement plans.
While not common, some employers may offer a 403(b) and 401(k) plan. In that instance, employees are still restricted to the current year’s limit for both plans combined. For example, if the limit is $22,500 and $10,000 is contributed to the 401(k), the max 403(b) contribution is $12,500.
Another unique, but not necessarily common, feature that may be available in additional catch-up contributions. Employees with 15 or more years of service with certain nonprofits or government agencies can contribute an additional $3,000 yearly. However, regardless of age, there is a lifetime limit of $15,000.
Like the 401(k), the 403(b) retirement plan is critical to retirement planning and saving for individuals with access to them. The automatic saving nature of the plan makes it very convenient to save for the future. Saving early, often, and as much as you can afford will set you up for your coveted retirement. Happy Saving!