What is a 403(b) Plan and How do You Use it?
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You’ve almost surely heard of a 401(k) plan, but what in the world is a 403(b) plan?
Simply, a 403(b) plan is a tax-advantaged retirement account for employees of schools, churches, and nonprofits.
In order to offer a 403(b), a non-profit has to be tax-exempt under the 501(c)3 code section of the IRS.
A 403(b) plan – aka tax-sheltered annuity or TSA – is similar to a 401(k) plan, but it has a couple of important differences.
Here’s how they work: if your employer is a public school, including a state university, a non-profit, or a church, your organization may have a 403(b) you can use to save for retirement.
(Find out if your nonprofit is 501(c )3 exempt.)
If you get a job with a nonprofit, school, or church, your organization is required by law to tell you if they have a 403(b) plan.
Most of the time, you should be able to start contributing to your 403(b) plan as soon as you start working. The sooner you start the more time your money has to grow and the bigger your savings will be.
The IRS stipulates that you’re always 100% vested in your automatic enrollment contributions. That means the money you contribute to a 403(b) plan is always yours, even if you leave the organization right away.
Your contributions to your 403(b) plan aren’t taxed unless you decide to contribute to a Roth plan (see below for more details).
That means you won’t pay taxes on any money you contribute to this plan until you withdraw the money in retirement. If you contribute a lot of your salary to your 403(b), it can affect how much you pay in taxes.
You can currently contribute up to $20,500 in a 403(b) plan, and if you’re 50 or older, you can contribute an additional $6,500.
Some organizations offer an employer match if you utilize the 403(b). If you contribute up to 3% of your salary, for example, the organization will match that 3%.
That’s like getting a tax-exempt 3% raise each year. So make sure you’re contributing at least the amount of your employer match.
However, this money may not immediately be yours.
Be sure to pay attention to your organization’s vesting schedule (i.e., the length of time you need to remain an employee of your organization to keep your employer match).
403(b) plans are eligible for Automatic Enrollment. That means some TSA plans will automatically enroll you in the plan and will sign you up to contribute a percentage of your paycheck, 3-6% unless you opt-out.
Sometimes these plans will increase the amount of your contributions by 1% per year, automatically, up to a specific limit.
Studies have shown that automatic enrollment dramatically increases the percentage of salary you save, so they’re a great idea.
If your 403(b) plan has a feature that automatically increases your contributions each year, take advantage of it.
You can set it up for the month when you normally receive a raise so you won’t even notice the extra money in contributions.
And remember–the amount you contribute to a 403(b) lowers the amount of taxes you pay. So if you’re contributing $100 per paycheck, your paycheck won’t be $100 lower; it will decrease less than that, depending on your tax rate.
If you leave your job, the money in your TSA account is still yours. You can roll it over into a regular or Roth IRA or another 403(b) or 401(k) account at your new job.
403(b) Versus 401(k) Plans
There are a couple of important distinctions between a 403(b) and a 401(k) plan. Read on for the most important.
If you’re 50 or older, you can also take advantage of the annual IRS contribution limit, which is $6,500 for 2022. This is the same catch-up contribution as the 401(k) plan allows.
But 403(b) plans have an additional feature their for-profit counterparts don’t have – the catch-up provision.
If you contribute to your 403(b) plan for at least 15 years, you’re allowed to contribute an extra $3,000 per year to your 403(b) account, with a lifetime cap of $15,000.
There’s no age for the catch-up provision, so you don’t have to be 50 or older to take advantage. This catch-up provision is in addition to the $6,500 annual catch-up contribution.
Fewer Fees But Less Matching
One significant difference between 403(b)s and 401(k)s is that TSA plans are not necessarily subject to strict IRS ERISA reporting.
That means they aren’t required to go through the yearly auditing and reporting many for-profit companies are.
Therefore, many 403(b)s can have much lower fees in their investment plans because they’re cheaper to administer.
But, for the same reason, non-profits may not offer high employee matches in their 403(b) plans so they don’t lose their ERISA exemptions.
So, while your 403(b) plan may have lower fees, you may also have a lower match from your employer.
If you’re an employee at a public college or university, your 403(b) plan may have an unusual feature–mandatory contributions.
Mandatory contributions are just what they sound like–required contributions from you into your 403(b) plan.
Your employer may require you to contribute a certain percentage of your salary–say, 3%, to your retirement plan–which they will then match.
The one good thing about this setup is that your mandatory contributions don’t count against your total retirement contribution limit. So, you can still max out $20,500 in 2022 in addition to your 3% mandatory contribution.
Investing in your 403(b)
Your Plan Options
What can you invest in with a 403(b)?
It depends on the organization you work for. Most of the time, your investment options look very similar to options in a 401(k) plan, but there are a couple of exceptions.
Initially, 403(b) plans were called Annuity Plans because you could initially only invest in annuity plans with them. That restriction has since been lifted, and you can now invest in annuities or mutual funds.
You cannot invest in individual stocks in a 403(b) plan, however.
Many 403(b) plans offer a selection of mutual funds through an investment company like Fidelity, Principal, or Vanguard. These options will probably look very similar to investment options offered in a 401(k).
It makes sense to invest in an S&P 500 index fund most of the time, which tends to have lower fees than other Retirement Date funds or specialty funds.
Some 403(b) plans offer an annuity contract, which is a type of insurance plan.
You make contributions for a certain number of years into the plan, and the insurance company agrees to pay you a monthly stipend once you retire.
If your plan offers both mutual funds and an annuity, in which should you invest?
The simple answer is mutual funds. Annuities often charge higher fees and lock up your money for years, giving you less investing flexibility than a mutual fund.
However, fixed annuities can guarantee a set income. So if you would rather have the security of a set amount of money each month, you may consider the annuity option.
If you’re a church member, your church may have a retirement income account set up for you that is run by a mutual fund company.
Designated Roth Contributions
Some 403(b) plans allow you to contribute after-tax income to your account. Why would you want to do this?
Roth contributions are made with after-tax money. So you pay tax when you contribute to the account, but not when you withdraw it.
So if you think your tax rate might be higher when you withdraw the money, or if you currently have an unusually low tax rate (because of income, age, or another reason), then you might want your contributions to be designated as Roth.
Your Roth contributions will be set up in another account since the IRS stipulates you need separate accounts for both tax-free and Roth contributions. Also, if your employer provides matching contributions, those cannot be added to your Roth account.
Just remember–you can only contribute the IRS maximum in total across both your pre-tax and Roth accounts. So if you’re already contributing the maximum $20,500 to your pre-tax account, then you cannot contribute to a Roth account.
Taking Out a Loan Against Your 403(b)
While experts are pretty united that it's a bad idea to take a loan out against your retirement account, sometimes it’s inevitable.
And loans against your 403(b) have some benefits if you’re in a financial pickle.
Your ability to take out a loan is dependent on your organization’s 403 (b) plan. Typically, you can take out either a general loan from your 403(b) or a home loan.
You have five years to repay yourself the money from your general loan and longer to repay yourself a home loan (your plan will designate the period, usually 15 years).
You don't need to prove hardship to take out a 403(b) loan, but you do have to apply for the loan and meet specific requirements.
Some loans require a spouse’s approval before making the loan. You’re not allowed to take out more than 50% of your account balance, or $50,000 in total, whichever is less.
So if you currently have $70,000 in your account, the maximum you would be able to take out as a loan would be $35,000.
Your repayments come directly from your paycheck, and you must pay yourself interest.
Also, if you leave your place of employment, you must pay the entire loan back at the time you leave.
If you don’t, the government considers that money a distribution. You’ll then have to pay ordinary income tax plus a possible 10% penalty if you’re under 59 ½ years old.
Just remember–even though you’re paying yourself interest on your loan, you’re probably not earning what your money could have in the stock market.
Lastly, while you’re paying your loan back, chances are you’ve stopped contributing to your 403(b), which can mean missing out on significant growth in your account later on.
Should You Take Advantage of Your Organization’s 403(b) Plan?
If you’re debating between saving for retirement in an IRA or your organization’s 403(b) plan, you should probably take advantage of the 403(b) plan.
First of all, if your company offers a match, that's extra, tax-deferred money you can contribute to your retirement.
Second, there's a much higher contribution limit for a 403(b) plan. And even if it feels like you could never contribute more than the IRA limit of $6,000, your circumstances may change.
The only exception to this might be if your organization doesn’t offer low-cost investing options in the plan.
Make sure to talk with your plan administrator to get the low-down on all of your investment options.
403(b) plans allow nonprofits to offer competitive retirement plans just like for-profit companies. Most offer great ways to save for retirement, so here’s to saving for the future you!
Article written by Laurie
Laurie is a team member of Women Who Money and the founder of The Three Year Experiment, a blog about building wealth in order to become location independent.