403 (b) Retirement Plan?

What is a 403 (b) Retirement Plan?

The 403(b) is a tax deferred retirement plan available to employees of educational institutions and certain non-profit organizations as determined by section 501(c)(3) of the Internal Revenue Code.

Contributions and investment earnings in a 403(b) grow tax deferred until withdrawal (assumed to be retirement), at which time they are taxed as ordinary income. The 403(b) is named after the section of the IRS code governing it.

How a 403(b) Works


Employees enroll and participate through their employer.Contributions to a 403(b) are made on a pre-tax basis through a Salary Reduction Agreement. This is an arrangement where the participating employee agrees to take a reduction in salary. The amount by which the salary is reduced is directed to investments offered through the employer and selected by the employee. These contributions are called elective deferrals and are excluded from the employee’s taxable income. Contributions grow tax-deferred until the time of retirement, when withdrawals are taxed as ordinary income. See Accessing 403(b) Savings and Making Other Changes to Your 403(b) for information on withdrawing 403(b) money.

Eligibility

Employees of tax-exempt organizations established under section 501(c)(3) of the Internal Revenue Code are eligible to participate. Participants include teachers, school administrators, school personnel, nurses, doctors, professors, researchers, librarians, and ministers. However, employers can restrict access based on such factors as hours worked. Check with your employer for details.

Job Change, Disability, Divorce, Death


What Happens to Your 403(b)
If You Leave Your Employer

  • Assets may be transferred to your new employer’s plan if permitted by that plan.
  • Assets may be moved to a rollover IRA at an institution of your choice. This wil permit the money to continue to grow tax-deferred.
  • You may leave the money in your current plan and continue to enjoy tax-deferred growth. If plan has less than $5,000 in assets you may be required to transfer assets. Check with your employer for details.
  • You can take a lump sum distribution, but early withdrawal penalties and tax consequences may apply (unless age 59½ or 55+ and retiring) See: Accessing 403(b) Savings for details.

What Happens to Your 403(b)
If You Become Disabled

You may be eligible for a distribution. This option is designated by each vendor and not by the plan. Contact your vendor for more information.

What Happens to Your 403(b)
in the Event of a Divorce

Some or all of the balance in your 403(b) account may be transferred. Distribution to an alternate payee will be permitted if it is made pursuant to a qualified domestic relations order (QDRO). This is a decree, judgment, or order that meets the qualification requirements of the Internal Revenue Code. Those requirements include the following:

  • The order must have been issued under a state’s community property or other domestic relations law.
  • It must relate to the provision of alimony, child support, or the property rights of a spouse, former spouse, child, or other dependent (alternate payee).
  • It must assign to the alternate payee the right to receive all or a portion of the participant’s plan benefits.
  • It must clearly specify (1) the names and addresses of each alternate payee, (2) the amount or percentage of the participant’s benefit to be paid to each alternate payee, (3) the period of time over which the order applies, and (4) each plan to which the order applies.
  • When discussing property distribution in contemplation of a divorce,you should make certain that your attorney ensures that the distribution of your 403(b) assets and all other retirement plan assets meet the requirements of a QDRO.

What Happens to Your 403(b)
in the Event of Death

Death benefits are paid to a beneficiary or beneficiaries on file with your vendor. How the proceeds are distributed depends upon the age of the participant upon death and beneficiary’s relationship to you. You should review your beneficiary designations annually and update them as necessary through your 403(b) vendor.

ERISA 403(b) vs. Non-ERISA 403(b)


The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans (Department of Labor). In general, ERISA does not cover retirement plans established or maintained by governmental entities, and churches (Department of Labor). This means that K-12 403(b) plans, public university and public hospital 403(b) plans, and church plans are generally considered to be Non-ERISA plans.

403(b)(7) Custodial Accounts

This is the name of the 1974 addition to the IRS code allowing participants to invest directly in mutual funds through a custodial account. Throughout this site “the 403(b)” will refer to a 403(b) plan allowing investment in both annuity products and mutual funds.

Tax-Sheltered Annuities (TSA)

The 403(b) is also known as a tax-sheltered annuity, but this is an outdated expression. It can give the impression that participants can only invest in annuity products, which was the case when section 403(b) was first added to the IRS code. However, since 1974, participants have also been able to invest in mutual funds through a 403(b)(7) custodial account. Throughout this site “the 403(b)” will refer to a 403(b) plan allowing investment in both annuity products and mutual funds.

How a 403(b) is Different From a Pension

Pensions, like CalSTRS in California, are formula-based retirement plans in which payout at retirement is based upon such factors as years of service and salary. Eligible employees are automatically enrolled in one of these plans upon employment. All investment decisions for these pensions are made by plan officials. In contrast, the 403(b) is a voluntary, self-directed plan in which payout at retirement is based upon how much money an individual accumulates in the 403(b).

How a 403(b) is Different From a 401(k)

The 403(b) is a retirement plan available to certain employees of public schools, employees of certain tax-exempt organizations and certain ministers. The 401(k) is a retirement plan for private sector workers.

Third Party Administrators (TPA)

A third party administrator (TPA) provides plan administration and compliance services to employers.

Roth 403(b)

This is a provision that permits employees to irrevocably designate all or a portion of their 403(b) as an after-tax Roth contribution. This type of contribution will not lower the employee’s taxable income. However, distribution of Roth designated funds in retirement will not be subject to taxation.

Participants have the option of making pre-tax 403(b) contributions, Roth 403(b) contributions, or as a combination of the two. Total contributions cannot exceed the year’s contribution limit. Not all employers offer a Roth 403(b), nor are they required to do so. Check with your employer for details.

How a Roth 403(b) Is Different From a Roth IRA

The tax treatment of a Roth 403(b) and a Roth IRA is similar (after-tax contribution, tax-free withdrawal in retirement). However, the Roth 403(b) is an employer-based plan, while the Roth IRA is an individual-based plan. Distribution rules are different. Roth IRA contributions can be accessed at any time (earnings after five years or until age 59½, whichever is later). The Roth 403(b) can be accessed only with the occurrence of a distributable event (age 59½, separation from service, disability, or death).

Contribution Limits

Participants may contribute up to $18,000 for year 2017. In 2016 and 2015 the limit was also $18,000. In 2014 and 2013 the limit was $17,500. It was $17,000 in 2012.

For those with employer matches or other employer contributions, the limit is $54,000 or 100% of compensation (whichever is less). The participant is still limited to the employee elective deferral limit ($18,000 for 2017). An employer can add up to another $36,000.

Age 50 Catch Up

Participants age 50 and older at any time during the calendar year are permitted to contribute an additional $6,000 in 2017. The age 50 catch up in 2016 and 2015 was also $6,000. From 2009 to 2014 it was $5,500.

15-Year Rule

Employees with 15 years of service with their current employer and an annual average contribution of less than $5,000 per year are eligible for an additional $3,000 contribution per year up to a lifetime maximum catch up of $15,000. This is known as the 15-year rule. For participants eligible for both the age 50 catch up and the 15-year rule, the IRS will apply contributions above the regular limit first to the 15-year rule. Employers are not required to make this provision available

403(b) and/or a Roth IRA?

Ideally, eligible participants would contribute the maximum allowableto both a 403(b) and a Roth IRA. If you are stuck with a 403(b) plan with bad choices or only have a limited amount to contribute to a retirement plan, you may want to consider funding a Roth IRA before funding a 403(b). Here’s how a Roth IRA works.

Roth IRA Eligibility

  • For 2017 single workers earning up to $118,000. Phases out at $133,000.
  • Married couples (filing jointly) earning up to $186,000. Phases out at $196,000

Roth IRA Contribution Amounts

For 2017 the limit is $5,500. In addition if you are 50 or older at any time during the year you can contribute an additional $1,000.

Roth IRA Tax Advantages

No pre-tax advantages, however, withdrawals of contributions are never taxed and are always available for withdrawal. Tax free withdrawal of earnings may begin at age 59-1/2 (account must be held at least five years). Tax free withdrawal of earnings prior to age 59-1/2 may be made in case of disability, first-time home purchase and death.

Roth IRA Pros Compared to a 403(b)

  1. Can invest money in any financial institution
  2. Can invest in individual stocks
  3. Withdrawal of contributions are never taxed
  4. Earnings grow tax-deferred
  5. Tax free withdrawal of earnings prior to age 59-1/2 may be made in case of disability, first-time home purchase and death
  6. Job change doesn’t affect account status or require changes
  7. Easy to arrange dollar cost averaging (purchase of a fixed dollar amount at regular intervals)
  8. No forced withdrawals at age 70 ½

Roth IRA Cons Compared to a 403(b)

  • Smaller contribution limit ($18,000 to 403(b) in 2017)
  • Does not lower taxable income
  • Does not lower taxable income
  • Not protected from creditors in all states

Not protected from creditors in all states

  • As long as you don’t exceed the income provisions you can contribute to both plans
  • If you are stuck with lousy investment choices in your 403(b), or are enamored with a particular financial institution, funding a Roth IRA may make more sense.
  • If your employer provides matching funds, the 403(b) may be the way to go, at least up to the match
  • Younger workers may be unable to contribute a significant amount to a 403(b), lessening the benefit of pre-tax savings. In this case the lower contribution total and vendor flexibility may make the Roth IRA the best choice.
  • One school of thought has investors splitting money between the two plans.
  • Uncertainty on future tax rates and policies further complicates the decision.
    So which plan is best for you? Only you can make that call. Much of it depends on what you believe your tax bracket will be in the future and whether the deduction is worth more to you today than tax-free income in the future. The real bottom line? Regardless of the plan you choose, get started. Now!

403(b) Distribution Eligibility

If you withdraw assets prior to age 59½, the IRS will impose a 10 percent penalty tax on the amount to be included in your taxable income in addition to the normal tax consequences, unless you meet one of the following criteria:

  • You separate from service during or after the year you reach age 55. This exception is permitted by §72(t)(2)(A)(v). See irs.gov for more information.
  • Retire before age 55 and arrange a schedule of Substantially Equal Periodic Payments (SEPP). The payments are based on an IRS formula and must continue for 5 years or until the individual reaches age 59½, whichever takes longer. This exception is permitted by §72(t)(2)(A)(iv) See irs.gov for more information.
  • Separate from service and move money to a tax-favored account such as another employers plan or a Rollover IRA
  • Disability
  • Divorce
  • Death
  • Made to an employee for medical care to the extent you have deductible medical expenses (medical expenses that exceed 7½% of your adjusted gross income), whether or not you itemize your deductions for the year.

Borrowing Money From Your 403(b)

Subject to availability and any additional conditions applied by individual vendors. IRS limits loans to the lesser of:

  • $50,000
  • One half of account value

403(b) Hardship Withdrawals

Hardship distributions are permitted by the IRS, but are not required to be made available. Check with your vendor for details.

Withdrawal Requirements for 403(b) Money

You must begin to take withdrawals from your 403(b) no later than April 1 of the year following the year in which you turn age 70½. If you are still working, you can delay withdrawal from your 403(b) until April 1 following the year in which you retire. See this IRS story on Required Minimum Distributions (RMD).

403(b) account balances that existed on December 31, 1986 are not subject to the age 70-1/2 distribution requirement. However, any earnings on that balance are. Distribution from the 12/31/86 balance needs to start at age 75. This requirement is not found in the Internal Revenue Code, but rather in a letter ruling. Also, any distributions in excess of required distributions are deemed to reduce the 12/31/86 balance. So, if any money has been taken out of the 403(b) account other than those that are required (such as a partial withdrawal or a deemed distribution), the 12/31/86 balance may be less than anticipated. For your specific situation it’s recommended that you consult a professional tax advisor.

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