When it comes to retirement accounts, 401(k) plans tend to get the most attention, but if you work at a school, hospital, library, research facility, church, or another organization qualified under IRS Section 501(c)(3), you probably know about 403(b) plans. A 403(b), sometimes referred to as a tax-sheltered annuity plan (TSA), is a retirement plan for employees of public schools and certain non-profit organizations.
- Employees of public schools and some non-profits qualify for 403(b) plans, sometimes referred to as tax-sheltered annuities.
- Contributions to a 403(b) plan are made with pre-tax dollars and the money you invest grows tax-free.
- You can only contribute so much to a 403(b) each year, but the limits are adjusted periodically, usually increasing, to keep pace with inflation.
- Some 403(b) plans allow you to contribute an extra $3,000 a year to “catch up” if you’ve worked for the same employer for 15 years or more.
The maximum amount you can contribute to a 403(b) plan from your salary for tax years 2020 and 2021 is $19,500. If you're 50 or older, this limit increases to $26,000 in 2020 and 2021. In addition to the employee contribution limits, more money can be added to a 403(b) if your employer offers to match contributions. For plans that provide an employer match, the total contribution limit is $57,000 in 2020 and $58,000 in 2021.
If you earned less than the contribution limit in your most recent year of working, you're limited to contributing the amount of your earnings.
Benefits of Contributing to a 403(b)
The primary benefit of 403(b) plans is that contributions are made through pre-tax salary deferrals, so you get the benefit of your money growing tax-free, as well as lowering your taxable income for the year. These plans used to be primarily invested in annuity contracts, with a separate account for fixed or variable rate of return investments. Now, the majority of 403(b) plans offer mutual fund investment options within custodial accounts. While some 403(b) plans still offer annuity investments, the use of diversified investment lineups of mutual funds is very similar to the structure of traditional 401(k) plans.
If you work for a company that offers a 403(b), you can help strengthen your retirement savings by taking advantage of dollar-cost averaging, which is when investors make periodic contributions to their investment or retirement accounts to offset the impact of market volatility. This is especially helpful for new or hands-off investors because it eliminates the need and urge to time the market and make irrational investing decisions.
Designated Roth Account
The designated Roth account (DRA) program allows organizations to designate 403(b) plan contributions as Roth contributions. Contributions are made with after-tax dollars, so there's no current-year tax deduction. However, earnings grow tax-free, and you can withdraw your money without any penalties as long as you are at least 59 1/2 years old, and it's been five years since your first Roth 403(b) contribution.
The annual contribution limits for a Roth 403(b) for tax years 2020 and 2021 are $19,500 for those younger than age 50 and $26,000 for those age 50 and older. If your plan offers a Roth 403(b) option, you can contribute to a traditional, pre-tax 403(b) and a Roth 403(b) in the same year as long as the combined contribution amount doesn't exceed the annual limit. You're eligible for a rollover to a Roth IRA at retirement to avoid taking required minimum distributions, but unlike a Roth IRA, there are no income restrictions.
Differences Between 403(b) and 401(k) Plans
401(k) and 403(b) plans are more similar than different these days, but this wasn't always the case. The Economic Growth and Tax Relief Reconciliation Act of 2001 eliminated previous differences between these two different types of retirement plans. However, one special election—referred to as the 15-year rule—is still in effect for 403(b) plans if the employer permits it. This special lifetime catch-up provision allows employees with 15 or more years of service with the same employer to contribute an additional $3,000.
Under current rules, this catch-up provision can't exceed $3,000 per year, up to a lifetime maximum of $15,000. If both the age 50 and the 15-year catch-up provisions are available, any contributions that exceed the $19,500 annual limit for 2021 and 2020 will first be applied using the 15-year rule, followed by the age 50 catch-up.