It can take a lifetime to save enough money to retire. That’s why it’s critical to understand your employer-sponsored retirement options as soon as possible. You may be familiar with 401(k) plans. However, if you work in public education or for a nonprofit, cooperative hospital, or religious organization, you will most likely have a different retirement option: the 403(b) plan.
What is a 403(b) plan?
A 403(b) plan is a tax-deferred retirement account for employees of public education institutions, nonprofits, and some religious organizations. To provide a 403(b) plan to its employees, the employer must meet IRS eligibility requirements.
How 403(b) plans work
403(b) plans are very similar to 401(k) plans (the numerical names refer to which part of the tax code each complies). They allow you to contribute a certain amount of your pre-tax income to a retirement fund, where it can grow tax-free until you begin taking distributions. Employers may also contribute to these plans.
“In 2022, employees can contribute up to $20,500 to a 403(b),” says Matthew Sanchez, a Certified Financial Planner and wealth advisor at Biechele Royce Advisors. “Employees aged 50 and up can contribute an additional $6,500, for a total of $27,000. Employers typically contribute to these plans, typically 1% to 5% of total compensation, just as they do to for-profit plans “ounterparts do.”
There are no two 403(b) plans that are alike. Individual employers consult with companies that provide and manage 403(b) plans to determine what they want to offer employees in their company-sponsored plan. Offering matching funds, the ability to take loans against a balance, and options for how employees’ money is invested are all possibilities.
At the very least, you should be able to make elective deferrals, or choose how much of your pay goes into your retirement account. Your employer may choose whether or not to contribute to your fund. They are not required to, but many do as an added benefit of employment. The maximum combined contribution to a 403(b) plan in 2022 is $61,000.
Employers also decide what kinds of investment options you have as a 403(b) plan participant. According to Kenny Senour, Certified Financial Planner with Millennial Wealth Management, plan sponsors decide what features their plans will have and what kind of vesting schedule they will offer. Employees are frequently given the option to self-direct their plan investments from a menu of options.
“Historically, the primary investment options for 403(b) plans were annuities,” he adds. “That type of option has some negative consequences in the form of complexity, potential surrender charges, and opportunity cost in the form of meager returns versus a comparable mutual fund.
Fortunately, for the sake of simplicity and transparency, many of these plans have moved toward a more ‘open architecture’ structure, in which participants have access to a streamlined investment menu of lower cost mutual funds.”
Withdrawal rules for 403(b) plans are similar to those for 401(k) plans.
Under the circumstances described above, your individual plan may allow you to take a loan against the funds in your 403(b) or apply for an early withdrawal without penalty. Early withdrawals that do not meet the exceptions listed above may be subject to a penalty of 10% of the amount withdrawn.
Your provider may determine when you can begin withdrawing money from your 403(b) plan. Though the IRS sets the minimum age for penalty-free withdrawal at 59.5, your plan’s contract may specify a different age. If you haven’t started taking withdrawals from your 403(b) plan by the age of 72, you must do so.
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“The types of withdrawals available to employees in retirement are plan specific,” Senour says. “However, employees typically have the option of rolling over their account to another qualified retirement account, taking a lump sum distribution, or setting up ‘installment payments’ on a monthly or quarterly basis.”
Except for money that was originally contributed to the account after taxes were paid, any withdrawal is considered taxable income for the year in which it is received. If you do not take the required minimum distribution from your account, you will be subject to a nondeductible 50 percent excise tax on the difference between the required minimum distribution and the amount actually distributed, according to the IRS.
