For nonprofit or public-school career professionals, the ticket to a golden retirement may very well come from their 403(b) retirement plan - the non-profit sector's go-to retirement plan.
Often called tax-sheltered annuity plans, 403(b) plans enable public educators, and workers at tax-exempt organizations to stash money away for retirement, on a pre-tax basis, with annual financial contribution limitations.
The money, usually invested in annuities or mutual funds, grows tax-free until withdrawn in retirement. Plan participants can take cash out of their 403(b) plans without fear of a 10% (of the withdrawal) penalty if they are 59½, or 55 years old if they're no longer on the job.
Any withdrawals on a 403(b) plan are taxed by the federal government, as regular income. Even so, that should be a net financial positive for a plan participant, as the employee will likely be in a lower tax bracket in retirement.
403(b) plans are more pervasive than one might think. The plans cover about 20% of U.S. workers and total plan asset volumes are around $1 trillion, according to the Investment Plan Institute.
Who Qualifies for a 403(b) Plan?
According to the Internal Revenue Service, the following career professionals are 403(b)-eligible:
- Eligible employees of Code Section 501(c)(3) tax-exempt organizations;
- Eligible employees of public school systems, including public grade school, middle school and high schools, state colleges, and universities.
- Employees of cooperative hospital service organizations.
- Eligible employees of churches.
- Employees of public school systems organized by Indian tribal governments.
- Ministers employed by Code Section 501(c)(3) organizations and ministers (chaplains) who meet both the following requirements:
- They are employed by organizations that are not Code Section 501(c)(3) tax-exempt organizations, and
- They function as ministers in their day-to-day professional responsibilities with their employers.
403(b) Plan Contribution Limits
Participants of 403(b) plans have contribution limits for 2018, as follows:
- 403(b) investors can elect to defer up to $18,500 of their salary, and steer it into a 403(b) plan for the 2018 tax year.
- Plan participants over the age of 50 can contribute another $6,000 in so-called "catch up" funds for 2018, while some 403(b) plan members can contribute an additional $3,000, if they have 15 or more years of experience in their field.
Here's how the 15-year model, known formally as the 15-year service rule, works.
If a 403(b)-eligible employee has at least 15 years of service, that employee may put away an additional $3,000 annually into his or her retirement plan, if the 403(b) plan contributions have not been maxed out in prior years. For the 2018 tax year, that means a 403(b) plan contributor with 15 years or more on the job could stash away $21,500 (the $18,500 annual contribution plus the $3,000 additional contribution.)
There are limits to the 15-year contribution rule - the rule has a $15,000-lifetime contribution limit.
For the 2019 tax year, Uncle Sam has boosted 403(b) contribution plan limits from $18,500 to $19,000, while the over-50 catch-up provision will remain at $6,000.
Employers can also contribute to an employee's 403(b) plan, much like a company can contribute matching funds to employee 401k plans. There is a limit on what 403(b) employers can contribute - no more than the sum total contributions in a calendar year (either $55,000 or 100% of all compensation for a staffer's most recent year - whatever figure is lower.)
According to the IRS, the total employer-allowable 403(b) plan contribution will rise $1,000 in 2019, from $55,000 to $56,000.
Tips for Investing Into Your 403(b)
1. Check for Company Matching
While not every employer offers company matching on 403(b) plans, it's worth checking with your organization's benefits specialist to see exactly where it stands on company matching. After all, it's free money and you don't want to leave it on the table.
2. Talk to a Pro
It's worth talking to a financial adviser, even if your employer doesn't offer access to one, and see if you're making the right moves and choosing the best investment plans with your 403(b).
3. Diversify Your Investments
While 403(b) plans differ, and one plan might offer investment vehicles than another doesn't, aim to have a good cross section of funds in your plan. Access to a fund that holds U.S. stocks, a fund that holds international stocks, and a fund that holds U.S. Treasury bonds, for example, is a good example of a plan that is properly diversified.
Above all else, make sure the investments in your 403(b) plan accommodate your long-term investment goals, your investment risk tolerance, and your current age. In general, the younger you are, the more risk you can take with your plan investment vehicles.
4. Distributions at Age 59½
The optimal time to withdraw from a 403(b) plan is after turning age 59½. That's when you may begin taking distributions out of a plan without incurring a tax penalty. Yes, you will be taxed on your distributions, so keep an eye on what tax bracket you're in as you enter retirement.
By law, you'll need to start taking required minimum distributions (RMDs) at age 70½.
5. Watch Out for High Investment Fees
As noted above, 403(b) plans often come with high investment fees relative to 401(k) plans.
That's because 403(b) plans usually include a healthy dose of variable and fixed annuities, which clock in with high investment fees. According to data from Aon Hewitt, variable annuities, which comprise 33% of 403(b) plan investments, have an average fee of 2.25%.
Compare that to a fund loaded with ETFs, with an average fee of 0.44%, and you begin to see why 403(b) plan fees are so high.
403(b) Plans Vs. 401(k) Plans
While both 403(b) plans and 401(k) plans exhibit common characteristics, especially the ability to park retirement cash away on a tax-deferred basis, they have significant differences.
- Early withdrawals. 403(b) plan participants are allowed to begin taking withdrawals at age 55 with no tax penalty incurred - well before 401(k) plan participants, who must wait until age 59½.
- Administrative expenses. 403(b) and 401(k) plans also differ when it comes to fees, although all retirement plans in each category are not the same, and can incur different fees on their own. By and large, though 403(b) plans have higher fees and administrative costs than do 401(k) plans, mainly due to annuity fees. These fees, largely present in 403(b) plans, can be as high as 2.5% and really take a bite out of plan profits.
- Investment options. While 401(k) plans have fairly expansive investment options, like stocks, bonds, mutual funds, exchange-traded funds and even individual stocks, 403(b) plans are generally limited to mutual funds and annuities, although recent trends have begun to show a more diverse investment selection with 403(b) plans.
- Investment plan changes. 401k plan participants generally have more opportunities to make changes to their investment portfolios, compared to 403(b) plan participants, who are often limited in their ability to change their plan investment choices.