Understanding 403(b) Retirement Plans

By Cynthia J. Drake. May 7th 2016

Given their growing popularity over the last several decades, you probably know what a 401(k) retirement plan is. However, you might not know that people working in the public or non-profit sectors are general ineligible for a 401(k) plan. Instead, people working in these sectors can enroll in a 403(b) individual retirement plan. The 403(b) is similar in many ways to the 401(k), but differs in who is eligible to enroll in it.

What Is A 403(b)?

Like a 401(k), a 403(b) account is considered to be a "tax-sheltered annuity" by the Internal Revenue Service. This means that any contributions plus accumulated interest earnings can grow tax-free until the funds are withdrawn during an individual's retirement.

Under a 403(b) account, eligible employees can direct their employers to set aside a percentage of their salary toward the account. Employers may also choose to match these funds.

How Is A 403(b) Different From A 401(k)?

Generally speaking, the major difference between a 403(b) and a 401(k) is who is eligible for each type of plan. 403(b) accounts are offered to employees of nonprofit organizations such as educational institutions, hospitals and religious organizations. 401(k) accounts are typically designated for for-profit corporations and businesses. Otherwise, the accounts operate the same way, with a few minor differences. According to TIAA-CREF, eligible employers that can offer 403(b) plans include:

  • Private colleges and universities
  • Independent schools
  • Research organizations
  • Teaching hospitals
  • Churches
  • Charitable organizations
  • State universities
  • Community colleges
  • K-12 public school systems

What Are The Annual Contribution Limits?

Like 401(k) plans, 403(b) plans have annual contribution limits. Participants in 403(b) plans were allowed to contribute up to $16,500 in 2011 and $17,000 in 2012, according to 403(b)wise, an information source for participants, employers and financial advisors.

If you are 50 years of age or older, you are allowed to contribute an additional $5,500 per the IRS's "catch-up rule."

There is also a provision for employees with at least 15 years of service with their current employer who have contributed less than $5,000 per year. They may contribute an additional $3,000 per year to a lifetime maximum of $15,000.

It is important to note that these contribution limits are quite high compared to a traditional IRA, which is limited to $5,000 per year.

What Are The Investment Options?

Investment options for 403(b) plans mirror those for 401(k) plans. You can usually choose from a large buffet from investment options. Many plans offer investment options which allow you to reduce your portfolio risk incrementally as you get closer to retirement age. The key is to make sure that you diversify your investments to reduce your overall portfolio risk. This involves picking a diverse mix of stocks and bonds.

When Can Funds Be Withdrawn From A 403(b)?

Similar to a 401(k), you cannot withdraw money from a 403(b) without paying a penalty unless:

  • You are at least 59 1/2 years old or
  • You become disabled or
  • You encounter financial hardship or
  • You have a qualified reservist distribution

Loans Against A 403(b) Account

People can take loans from their 403(b) accounts, but they must repay funds – including interest – within five years of taking out the loan. However, if they take out a loan for the purchase of a new home, they have 30 years to repay the loan. Loans that are not repaid within the required time period are subject to a stiff 10 percent penalty.

What Happens If You Get A New Job?

If you change jobs and are no longer employed by a 403(b)-eligible employer, you have a number of options available for your retirement nest egg, according to 403(b)wise. Your options include:

  • You can leave the money in the plan, as is;
  • You can transfer the funds to your new employer's retirement plan;
  • You can move the funds to a Rollover Individual Retirement Account (IRA);
  • You can take a lump sum distribution. Note that if you are not age 59 1/2, you may be subject to early withdrawal penalties.

What About The Roth 403(b)?

Employees may also choose to contribute to a Roth 403(b), which allows them to designate some or all of their 403(b) savings as post-tax contributions. If you believe that your rate of taxation is lower now than it will be at your time of retirement, the Roth savings may be a better vehicle for you since your contributions will be taxed at today’s tax rate.

People may choose to make pre-tax 403(b) contributions, Roth 403(b) contributions or a combination of both types of accounts. However, not all employers offer the Roth option.

The bottom line about 403(b) plans is that they are very similar to 401(k) plans. If you work in the public or nonprofit sector, make sure you do your homework before you make your retirement investment.

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