Important Facts About a 403(b)
If you are a public-school employee or an employee of a tax-exempt institution, such as a hospital, college, government organization or some religious institutions, you were likely offered a retirement plan known as a 403(b). If so, here are some 403(b) facts you should know.
A 403(b) plan is very similar to the more common 401(k) plans offered by for-profit corporations in many ways, but some significant differences also exist.
At Scarborough Capital Management, we specialize in 403(b) plan management (as well as 401(k) plan management) and are asked some of the same questions from clients who rely on these plans in retirement, specifically, their advantages and how they differ from 401(k)s.
If you have a question that is not addressed here, contact us. Regardless of the retirement plan you’re offered through work, there are some key facts you should understand.
Benefits of a 403(b) Plan
Participation in a 403(b) plan can help power your retirement savings for several reasons.
First, you can contribute up to $19,500 for both 2020 and 2021. If you are 50 years old or older, you may contribute an additional $6,500 for each of those years as a catch-up contribution. These amounts are the same as for a private-sector 401(k), but they are much less than the yearly amounts allowed in Individual Retirement Accounts (IRAs) (which is just $6,000 per year with a $1,000 catch-up).
Some organizations offer employees both 403(b) and 401(k) plans. If that’s true of your employer, you can participate in both but the contribution limits in one year for both plans can’t exceed a total of $19,500 (with a $6,500 catch-up, if you’re eligible).
Some employers that offer 403(b) plans offer additional catch-up contributions of $3,000 annually if you’ve worked at least 15 years steadily with the company. These are not available with a 401(k).
Second, many employers offer a match of up to 100 percent of the employee contribution. In other words, if you contribute 3 percent of your own salary, your employer may match up to that percentage, making your total retirement savings 6 percent of your salary.
It’s important to understand whether you receive a match, and if so, how much it is. Some 403(b) plans don’t offer a match, because 403(b) plans are not required to meet all the regulations contained in the Employee Retirement Income Security Act (ERISA) like 401(k) plans are. If your employer has set up a non-ERISA plan, your employer cannot offer a match. If your employer does offer a match and you don’t take advantage of it, you are leaving money on the table.
Another benefit of a Traditional 403(b) plan is that the contributions are not taxed in the year of contribution, which can save you considerably on taxes and may lower your tax bracket. The amount you elect to contribute is taken out of your paycheck pre-tax. The money is not taxed until you withdraw it in retirement.
One note about withdrawals: Because 403(b)s are retirement plans, the IRS will assess a 10 percent penalty if you withdraw funds before you turn age 59-½ and levy your ordinary tax rate on the withdrawn amount. There are several exceptions to the withdrawal penalty before you are 59-½. You may be able to make withdrawals for certain expenses, such as high medical bills, without incurring a penalty. Also, the Rule of 55 allows an employee who retires, quits or is fired at or after age 55 to withdraw without penalty from their 403(b).
While Traditional 403(b) plans are the most common, some employers offer Roth 403(b) plans. The taxation of Traditional and Roth accounts is quite different. If you invest in a Roth 403(b), the tax advantages occur at a different time in your life. The Roth contributions will be taxed in the year of contribution, but the money will not be taxed when you withdraw it in retirement, as long as you have held the plan for five years or more.
Investments to both Traditional and Roth 403(b) plans grow tax-deferred. Interest or appreciation is taxed upon withdrawal in a Traditional 403(b).
One perk that 403(b) plan holders have is an often very attractive vesting schedule – much more attractive than 401(k) plans.
Vesting refers to the schedule by which you become legally entitled to any matched funds. It can be a period of months or years. Many 403(b) plans vest immediately. Others have a much shorter timeline than 401(k)s do. This means that if you were to leave your employer, vesting governs whether you own the matching funds and can take them with you if you choose. If you vest immediately, you don’t lose any matched funds.
For more on retirement and a job change, read our recent blog post: Your Retirement Plan and a Job Change: What You Need to Know.
What to Watch Out For in a 403(b)
Participants in 403(b) plans need to be careful about 2 elements of the plan.
The first is the investment choices. Participants can usually choose from a wide array of options, including annuities, Tax-Sheltered Annuities (TSAs), insurance products and mutual funds. Annuities are set up to pay regular disbursements in retirement, somewhat like a pension does.
These choices are quite different than those in a 401(k), which more commonly offer stocks and bond funds rather than annuities. Annuities are more common in 403(b) plans because many of these plans were initially set up as annuities.
These choices, particularly annuities and insurance products, can be complicated and are not intuitively easy to understand. It’s very helpful to discuss your options with a financial advisor – be careful when making decisions you’re not sure about!
The second element to watch for is fees. While fees may sound like a low percentage, at around 1 to 2 percent, they can be higher or lower than other types of retirement plans. Even a low percentage fee can erode the value of your retirement savings over time, so investors should be aware of what they’ll pay.
The fees in a 403(b) plan can vary according to your investment choices. Again, discuss your options with a financial advisor and understand the ramification of your decisions.
A 403(b) plan can be an excellent and advantageous tool in retirement, but these plans can be hard to navigate. Don’t be afraid to ask for help! Schedule a no-obligation conversation with the team at Scarborough Capital Management. A simple discussion can go a long way.