403b retirement plan – What is it?
403 b is a tax-sheltered annuity plan which is ideal for employees of public schools and churches and not-for-profit companies. The main difference between the 403 b plan and 401k is the employment type and the type of investments allowed in each plan. Employees working in charity or tax-exempt organizations and other industries can start putting money in retirement accounts and annuities under code section 501(c)(3). Employees who do not fall under section 501(c)(3) but carry out professional responsibilities daily, such as certain ministers and others in a tax-exempt organization, can also save for retirement using the 403b plan. Certain employees may also be eligible for special plans and tax benefits under 403b, especially those who have been with the same employer for over 15 years.
What are the differences and similarities between the 403b and a 401k?
403 b is very similar to a 401 k retirement plan in various ways. For one, their contribution limits are the same at $19,500, and they both offer several tax advantages. Like the 401 k plan, 403 b also offers Roth options and can allow investors to withdraw funds from their individual account type without penalty when they reach 59½ years. Eligible employees who are older than 50 years can also contribute catch-up contributions of up to $6,500 and not pay taxes until withdrawal.
When it comes to differences between the two, the retirement account holders under the 403 b plans are not mandated to follow some of the regulations in the Employee Retirement Income Security Act. That means the retirement plan is not subject to nondiscriminatory testing, which is done every year to prevent high-level employees from getting disproportionate retirement earnings from any plan. The exemption to the rules is because the Department of Labor does not perceive 403b plans as employer-sponsored when the contributions do not come from the employers. However, if your employer pays the contributions, the investments will be subject to the same rules as 401 k plans.
With 403 b plans, the investment funds should be under a registered investment company, which does not happen with 401k investments.
The 403b retirement investment plan legally allows employer matches, but most employers fear making that contribution because it would force them to comply with Employee Retirement Income Security Act. Lesser requirements for those not obligated to follow ERISA result in a lower expense ratio.
401 k plans also tend to have higher match rates compared to 403 b. However, government employees who have been employed with the same agency and those working for non-profit organizations for 15 years can make catch-up contributions only under the 403 b plan.
The plan sponsors and plan participants also differ in each type of plan. In most cases, the 401 k plans are monitored by mutual funds, while 403 b plans fall under insurance companies. For this reason, 401k plans give more investment options compared to their 403 b counterparts, which feature more annuities.
What are the benefits of the 403b plan?
The earnings you get from 403 b plans are usually tax-deferred until the point of withdrawal. However, in most cases, the returns can only grow tax-free if they meet the eligibility standards for the distributions.
Matching distributions are possible for employees investing under 403 b plans, but the exact contribution limits will depend on the type of employer. Some plans or investment types may not allow the matches, but they will attract lower administrative costs. Those who get employer matches stand to gain a lot of extra money, but you can also enjoy low-cost investing if you don’t.
Not being under the ERISA oversight also brings the advantage of lower administrative charges.
Most of the 403 b plans also allow immediate vesting of funds, which is unlike 401 k plans. Being with an employer for a longer duration, usually more than 15 years, also has additional perks. Employees who are over 50 years can put more contributions into the retirement funds, the same way 401k investors do. The amount can be as high as $21,000 annually, depending on your employment status and the specific retirement plan you have. If you are behind on your retirement plans, this can be a good investment strategy with more tax advantages. If you are younger than 50 years and have been with the same employer for one and a half decades, you can save an additional $3000 per year.
Some 403 b plans are subject to default savings levels. Employers may set a specific percentage, for instance, 3%, to go into the plan every end month. For people who do not save enough or employees become too engrossed in other responsibilities than savings, this arrangement can be very beneficial. Even so, the savings may not be enough to cater to your needs after retirement if it is only a single digit. Remember, the money you set aside will depend on your salary and your specific investment objectives, but a savings rate between 10% and 15% should be enough. You can contribute more if you have higher pay or are behind on savings. Check your default saving rate to ensure it is sufficient for your future investment objectives.
You can always opt-out and use the retirement funds before you quit employment. It is still good practice to leave the money until after retirement, but if you need to, you can enjoy a lower tax bracket when you withdraw. On the other hand, 401k has hefty tax penalties on early withdrawals. You must still be cautious because the rules are only flexible with 403 b plans if you leave your employer.
Tax-deferred withdrawals under 403 b are only possible under specific circumstances, such as when leaving the employer at 55 years of age, becoming disabled, or needing to pay specified medical expenses. Failure to meet those conditions can cause you to pay taxes of not less than 10%, which is still very high.
Most retirement saving plans have a wide range of investment options to make it easier for people with varying needs and preferences to enjoy a comfortable retirement. 403 b plans tend to have limited investment options because they are not managed by mutual fund companies, which have more versatile investment categories. The few plans that offer mutual funds have variable annuity as part of the deal, which still restricts the investment choices. For instance, you cannot invest in real estate investment trusts or stocks. The main focus of the plans remains as variable annuities, which is in line with the original tax-sheltered annuity plan it provided before.
Not having ERISA protection is another major disadvantage because it does not protect investors from unscrupulous creditors. Understanding the laws provided by your Federal Government Agency concerning them can help you avoid nuisances caused by some of them and ensure you don’t pay taxes where applicable.
Contributions in 403 b plans
Some of the contribution plans involved in a 403 b include:
These are also known as voluntary employee contributions because they are not designated Roths. Since they are earnings paid by the employees, they are usually categorized as compensation for the year of contribution. They are included in the gross salary and are subject to income tax code on such.
These contributions are made as a result of an agreement between the employers and employees. The employer offers to pay the agreed-upon amount of money from the employee’s salary and deposit it in a 403 b plan.
Designated Roth contributions
These are all the electives that the employee decides to include in their gross salary. There must be separate accounts for all the contributions, profits, and losses in the Roth account type.
Non-elective employer contributions
Total contributions that are not made because of an agreement fall in the non-elective category. They include discretionary contributions, all mandatory employee contributions, and employer matching contributions. These contributions are only taxable upon withdrawal.
Additional contribution rules
All employees should be given a chance to make elective deferrals to a 403 b plan. Employers are mandated to give all their employees the same offer after they give it to one person. However, there are specific cases when this rule does not work. For instance, employees that contribute less than $200 per year, those who participate in 401k plans, or those who work less than 20 hours per week will not be given the same offer.
Some plans allow employers to continue to pay for employees after they leave. However, it can only be done in 5 years, and the annual limits must not be more than $58,000. The payments must stop if the employee dies. At the same time, employers are not mandated to make any contribution to any type of 403 b plan.
Employers have the power to terminate a 403 b plan under the right conditions as stipulated in the Treasury Regulation Section 1.403(b). In case of a termination, all your accumulated assets will be distributed to the beneficiaries and 403 b plan participants within the shortest time possible. More details about different ways of funding and taxation are available on Revenue Ruling 2011-7.
403 b plan investment types
403 b retirement saving plans have three main investment types:
- Mutual funds can be invested in using custodian accounts
- Insurance companies providing variable annuities or contracts
- A retirement income accounts for church employees or self-employed ministers
There can be investment changes if the plans that are to be exchanged meet the set requirements. For example, the transferring and receiving plans must have stipulations allowing such processes, the assets being transferred must belong to an employee or the recipient plan, or the benefits available in the transferring plan must be taken to the receiving plan.
403 b plans have several advantages to those approaching retirement and working in tax-exempt organizations like public schools, just like the 401k retirement plans. However, you need to consider all your options carefully to ensure the retirement plan you choose to invest in serves your objectives and helps you save enough money to live comfortably after retirement. Speaking with an expert in retirement planning who can guide you on these things would be a good place to start. Weigh the pros and cons of the 403 b plan or consult your financial advisors or any financial professional, and compare them to other retirement plans before selecting.