Explanation of a 403(b) Retirement Plan

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A 403(b) plan is a tax-deferred retirement savings account offered to employees of nonprofit or 501 (c)(3) organizations, including public schools, hospitals, museums, churches and charitable organizations. That's a lot of code (and these plans are literally named for their tax codes) but it's easier to think of the 403(b) plan as a 401(k) for the nonprofit sector. Whereas public employers do not have to offer 401(k) plans to their employees, all full-time nonprofit employees are eligible to participate in a 403(b) plan.

A 403(b) plan might also be known as a tax-sheltered annuity or TSA plan. That's because some 403(b) plans invested in annuity contracts. In fact, all of them did before the mid-1970s. An annuity is an insurance contract. Investors make contributions to the annuity with the guarantee that a specific amount will be repaid with interest in retirement, either in a lump sum or in regular payments throughout your retirement lifetime. Some annuities offer a fixed amount of interest guaranteed, others offer an amount that will vary with investment returns. But annuities can be more expensive than traditional mutual fund investments, and the penalty fees can be steep if you withdraw your money early from an annuity. So compare carefully. Today, many 403(b) plans offer participants the option to invest in mutual funds through custodial accounts, just like you would find in a 401(k) plan. Some 403(b) plans offer a combination of mutual funds and annuities.

Benefits of 403(b) Plans

The benefits of a 403(b) plan are similar to those of a 401(k). Regular contributions are taken out of your paycheck on a pre-tax basis, so you don't pay income tax on the money that you contribute. Anytime you can lower your taxable income, you have the opportunity to lower the taxes you pay.

(Think of this as a bonus, and it will help you take full advantage of all pre-tax employee benefits.)

The money that you contribute to a 403(b) plan grows tax-deferred until you start to withdraw it at retirement, beginning at age 59 1/2. So too do the investment gains and earnings. Tax-deferred growth helps your money accumulate more quickly. In other words, it helps you maximize your savings potential. And since many of us will have lower incomes in retirement than we do during our working years, the income tax that you eventually pay when you withdraw the money may be lower than it would be today.

As with 401(k) plans, if you withdraw your money before age 59 1/2, you will pay a 10% penalty fee, plus any applicable federal, state and local income taxes. This can really reduce your total savings amount—and potentially put your retirement at rist—so careful consideration is recommended. If your employer allows 403(b) loans, you may want to consider that in a cash crunch before deciding to withdraw the money completely.

Roth 403(b) Plans

Some employees may also have access to a Roth 403(b) plan, which is slightly different. With a Roth, you make after-tax contributions, but you do not pay taxes when you withdraw the money at retirement.

If you suspect your taxes will be higher at retirement than they are today, a Roth 403(b) may be an attractive option.

403(b) Plan Contribution Limits

Participants in a 403(b) plan can generally contribute as much as $18,000 to the plan in 2016. If you are age 50 or older and your employer allows something called catch-up contributions, your limit increases by $6,000. The same is true for a Roth 403(b). The total elective contribution limit is $24,000 in 2016. Limits typically increase each one to three years. They adjust for inflation in $500 increments.

403(b) Plan Matching Programs

Some employers might offer to match the contributions you make to a 403(b) up to a certain amount. If your employer does this, you should take advantage of it by contributing at least as much as they will match.

Again, think of it as a bonus, or that raise you still hope to get. If the match is 50% and you put in $1000, your employer puts in $500. It's money they are offering to you, that will benefit your future. Why leave it on the table?

So if you are an employee of a nonprofit organization, anytime you read something about a 401(k) plan, substitute the term 403(b) plan and follow the same advice. It's one of the best investments you can make for retirement.

The information included here is not professional financial advice. It is intended for guidance only. Any private (non-governmental) websites linked to from this piece are included for informational purposes and cannot be verified. While we every effort is made to ensure that this information is correct, it may vary depending on your own personal circumstances.