A 403(b) plan is an employer-sponsored retirement plan for certain employees of public schools, tax-exempt (501(c)(3)) organizations, and churches. It is very similar to a private sector employer’s 401(k) plan and can be an excellent way to save money for retirement. It can serve as a supplement to a traditional pension plan or other retirement plan(s), or as a stand-alone plan.
How does a 403(b) plan work?
Depending on the specific type of 403(b) plan, contributions may be made by the employee, the employer, or both. Similar to a 401(k), you can elect to defer receipt of all or part of your income to your 403(b) account. The amount you defer (called an “elective deferral”) can be either pretax or, if your plan permits, after-tax Roth contributions.
Employer contributions, if made, may be a fixed percentage of your compensation, may match a specified percentage of your contribution, or may be discretionary on the part of the employer. One unique characteristic of 403(b) plans is that your employer is allowed to make contributions to your account for up to five years after you terminate employment.
Who can participate?
In general, if one employee is eligible to make elective deferrals, then all employees must be allowed to do so. This is called the “universal availability rule.” However, your employer can exclude certain groups of employees from participation (for example, employees who normally work less than 20 hours per week, or who are eligible under another deferral plan of the employer).
What are the contribution limits?
You can defer up to $22,500 of your pay to a 403(b) plan in 2023. If your plan allows Roth contributions, you can split your contribution between pretax and Roth contributions any way you wish as long as you do not exceed the annual limit.
Contributions made by your employer do not count against the amount that you are allowed to defer. The total contributions to your 403(b) account - both yours and your employer’s - cannot exceed $66,000 in 2023 (or 100% of your compensation, whichever is less).
If your plan permits, you may also be able to make “catch-up” contributions to your account. This can be done in two different ways. The first catch up opportunity is available if you will be age 50 or older by the end of the year. If so, you can contribute up to an additional $7,500 in 2023.
The second opportunity is If you have 15 years of service with your employer. If your employer has adopted this plan feature, you may also be allowed to make annual catch-up contributions of up to $3,000 a year for a total of up to $15,000 lifetime. This second catch up option is not always available under an employer’s plan and not everyone is automatically eligible for the $3,000 a year or $15,000 lifetime amounts. You should discuss these options with your financial advisor.
The age 50 catch-up contributions do not count against the annual deferral limit, but the 15 years of service catch-up contributions do.
Income tax considerations
When you make pretax 403(b) contributions, you don’t pay current income taxes on those dollars (which means more take-home pay compared to an after-tax contribution of the same amount). But your contributions and investment earnings are fully taxable when you receive a distribution from the plan. In contrast, your after-tax Roth 403(b) contributions are subject to income taxes up front, but are tax free when distributed to you from the plan. And, if your distribution is qualified (made after a five-year waiting period, and the payment is made after you turn 59½, become disabled, or die) the earnings are tax-free as well.
Your employer’s contributions are always made on a pretax basis, even if they match your Roth contributions. That is, your employer’s contributions, and any investment earnings on those contributions, are always taxable to you when you receive a distribution from the plan.
If you receive a payment from your 403(b) account before you turn 59½ (55 in certain cases), the taxable portion may also be subject to a 10% early distribution penalty, unless an exception applies.
When can I access my money?
In general, you can’t withdraw your elective deferrals from your 403(b) until you reach age 59½, become disabled, or terminate employment. Some plans allow you to make a withdrawal if you have an immediate and heavy financial need (“hardship”), but this should be a last resort—not only is a hardship distribution a taxable event, but you may be suspended from plan participation for
six months or more. If your plan allows after-tax (non-Roth) contributionsyour plan can let you withraw these dollars at any time (not earnings). If your plan permits loans, you may be able to borrow up to one-half of your vested 403(b) account balance that you own, up to a maximum of $50,000, if you need the money.
What happens when I terminate employment?
You have several options available too when you leave an employer; you can leave your money in your 403(b) account, transfer it to a new 403(b) account, roll your dollars over to an IRA or to another employer’s retirement plan, or take a distribution.1 You will need to be vested in order to keep any money your employer may have contributed on your behalf. Your own contributions are always 100% vested.
What else do I need to know?
You must begin taking required minimum distributions (“RMDs”) from your 403(b) account after you reach age 72 (or after you terminate employment, if later). The RMD rules don’t apply to contributions made prior to 1987.
Your 403(b) account is fully protected from creditors under federal law in the event of your bankruptcy. If your plan is covered by ERISA, then your account is generally protected from all of your creditors’ claims.
While your pretax deferrals aren’t subject to income tax when made, they are subject to FICA tax. Your Social Security benefits are not affected by your decision to make pre-tax contributions to your account.
Retirement is tied in with having the opportunity and assets to do the things you appreciate most throughout everyday life. We can assist you with building your retirement savings and explain how it works with your pension and other benefits. Regardless of where you are financially - whether the early stages of your career, the middle, or approaching the end of it - there are solutions to make your golden years some of the most enjoyable years of your life.
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