What Is a 403(b) Plan?
Everyone knows that planning for retirement is important. That's why when you start your first job, you should also start saving for retirement by investing in a 401(k) plan. But some employers do not offer 401(k) plans, and instead may provide a pension or a 403(b) Tax-Sheltered Annuity (TSA) plan.
While perhaps not as well-known as 401(k), a 403(b) plan is a type of retirement savings account offered to employees of tax-exempt organizations such as nonprofits, churches, hospitals, and public education institutions.
The plan, which employers may offer as part of an employee's benefits package, can actually benefit both parties and offers a few different ways to invest the funds within the 403(b) account.
Benefits of a 403(b) Plan
The benefits of a 403(b) plan are similar to those of a 401(k) plan. They include:
- The ability to attract and retain employees by offering matching benefits. For instance, a company may offer to match employee contributions to their 403(b) plan dollar-for-dollar on the first 5% of payroll.
- Pre-tax contributions to a 403(b) plan and earnings on these amounts are not taxed until they are distributed from the plan.
- Money in a 403(b) can grow tax-deferred for decades, resulting in far more wealth for the owner of the account. Only when he or she begins to take withdrawals from their 403(b) account will they pay taxes on the funds.
- Earnings and gains on amounts in a Roth IRA contribution program aren’t taxed if your withdrawals are qualified distributions.
- You may be eligible to take a credit for elective deferrals contributed to your 403(b) account.
- Account holders can take loans against their 403(b) when they are in emergency need of cash. These 403(b) loans must be paid back, just like their 401(k) counterparts, or there will be significant tax consequences.
How Much Should I Contribute to a 403(b)?
The average goal for most people is to save around 15% of their income for retirement each year. Your employer match also counts towards that total.
On that note, you should always take full advantage of your employer match if you have one since it's basically free money, earmarked for your retirement.
When you are investing for retirement, a good plan of action goes as follows: Invest in your 403(b) up to the full amount that your employer matches. Each time you get a raise, increase the amount of your contribution. Then, max out your IRA contributions. If you still have funds you'd like to invest in your retirement, return to your 403(b) until you've reached the 15% goal.
403(b) Contribution Limits
The government provides fairly high 403(b) contribution limits for those who want to plan for retirement. The maximum potential 403(b) contribution is $57,000 per year for fiscal year 2020 if you meet certain conditions. The following is a breakdown of the potential 403(b) contributions that can be made:
- Basic salary deferral (the maximum payroll amount an employee can contribute to their 403(b) plan by having money taken out of their check) is $19,500 for fiscal year 2020.
- Employees 50 years and older can add $6,500 per year in special 403(b) contributions called “catch-up” 403(b) contributions. This is in addition to the $19,500 they can put aside as a regular employee.
- Some people are eligible for an additional 403(b) contribution known as a 403(b) Lifetime Catch-up. This special type of 403(b) contribution is only available to employees who have worked for a qualified organization for 15 years or longer. Often, this special 403(b) contribution is referred to as the “15-year rule” from IRS Publication 571.
The government allows these 403(b) contribution limits to increase for inflation by releasing the cost of living adjustment figures each year.
Choosing High-Risk or Conservative Investments for Your 403(b)
Just as with a 401(k) plan, you will have the option to choose to invest in conservative, middle or high-risk investments. When you are in your 20's, it makes more sense to choose higher-risk investments. The rate of return on these investments is higher than the conservative investments. When you are young, you can afford to ride out the market. This means you will have a chance to recover if the market drops.
However, as you near retirement age, you should begin transferring your funds to more conservative investments. You can re-balance your 403(b) portfolio by talking to a human resources representative at your company. You may also choose to seek the advice of a financial advisor. It is important not to panic if your portfolio drops due to a market dip.
Whether taking more bold steps or being conservative, think about how much you are willing to risk and how long it will be until you retire. If you're looking to invest your 403(b) more effectively, you should also consider monitoring your account, but try not to panic if the market dips. And as you get closer to retirement age, be sure to adjust your portfolio accordingly.
Should I Save for More Than Just Retirement?
If you want to build wealth, you will need to save more than just the money you put towards retirement each year. You should have regular savings goals that you set for yourself. These goals should include an emergency fund, a down payment for a home, and money for your children’s education in the future.
After those goals are met, you may want to save up for larger projects around your home, or maybe even your dream vacation. You may also choose to invest in real estate or to put additional money in the stock market. However, keep in mind that real estate is a risky investment.
There are a few tips to should take into consideration if you're looking to grow your net worth. First, make your retirement savings a priority. Second, if you plan on retiring early, you will need to build investments that you can draw on before you reach retirement age. Finally, consider talking to a financial adviser to set up a plan that will allow you to reach your goals on your timeline.
What Happens If I Change Jobs?
Once you are vested in your 403(b) plan, you can take the money with you when you change jobs. You will likely need to roll it over in an IRA account. If you are not vested, you will lose your employer’s contributions, but you will keep the money that you have put into your retirement plan yourself.
Some employers will require you to roll over the account, others will allow you to stay with the current plan as long as you have a specific amount in the account. If you have any questions, your human resources representative should be able to answer your questions or connect you with someone who can.
IRS. "Retirement Plans FAQs regarding 403(b) Tax-Sheltered Annuity Plans." Accessed April 27, 2020.
IRS. "Publication 571 (01/2020), Tax-Sheltered Annuity Plans (403(b) Plans): For Employees of Public Schools and Certain Tax-Exempt Organizations." Accessed April 27, 2020.
IRS. "Hardships, Early Withdrawals and Loans." Accessed April 27, 2020.
Vanguard. "401k vs. IRA? Use both if you can." Accessed April 27, 2020.
IRS. "Retirement Topics - Catch-Up Contributions." Accessed April 27, 2020.
IRS. "Coordination of the 15-year Rule and Age 50 Catch-ups, Attachment #2." Accessed April 27, 2020.
IRS. "403(b) Plan Fix-It Guide - An employee making a 15-years of service catch-up contribution doesn’t have the required 15 years of full-time service with the same employer." Accessed April 27, 2020.
Federal Reserve Bank of Dallas. "Building Wealth." Accessed April 27, 2020.
U.S. Securities and Exchange Commission/Investor.gov. "Switching Jobs." Accessed April 27, 2020.