What Is a 403(b) Plan?
The 403(b) plan is a retirement plan (that’s tax-advantaged) for ministers, public schools, and nonprofit employees. It’s also a defined contribution plan. This means that an individual knows how much their investing, but not what they will receive back. It’s all depends on how their investments perform. On the contrary, a pension is a benefit plan where an individual receives a payout based on their salary history and years of service. IRA’s, 401(k)s, 403(b)s are more popular and well-known than pensions in today’s society.
If you have a good knowledge of how a 401(k) works, understanding a 403(b) is easy. If you don’t know the difference between the two, no worries! Let’s go into further detail.
How Do 403(b) Plan Work?
With this type of plan, an individual contributes their salary reductions (deferrals) to a participant-directed account. There is a cap on these contributions that the IRS place (Internal Revenue Service) that’s under the IRC (Internal Revenue Code). The cap is to an annual maximum dollar amount.
When the money hits your account, you decide where you want to put your money towards. Your employer (plan sponsor) determines the options you have to put your money towards. Remember, there is always a risk when putting money into the market. In addition to, you can take a loss of principal. As you become more involved with this type of plan, we can help you understand the risks and how to deal with them.
Who Can Contribute To a 403(b)?
Those who are a part of tax-exempt organizations that fall under the 501(c)(3) IRC. Furthermore, another way to identify these organizations is by the name section 501(c)(3) organizations or 501c3 organizations.
Examples of participants include the following: school administrators, teachers, doctors, nurses, professors, librarians, researchers, ministers, etc.
403(b) Contribution Limits
There is a cap on elective deferrals to 403(b) plans just like there are on 401(k)s. The maximum amount an employee can contribute to a 403(b) out of their salary is $18,500 in the year 2018. At the end of the year, employees that are 50 years old and older can contribute an additional $6,000.
There is a limit on annual additions; the limit is usually $55,000 or 100% of the taxable wages an employee received according to their most recent year of service. By the way, a limit on annual additions is the combination of all employer contributions and employee deferrals to all 40(b) accounts.
How Much Should I Contribute to a 403(b)?
The goal for most people is to invest fifteen percent of their income toward retirement each year. The monetary amount your employer contributes on your behalf count towards the match. An employee has the choice to divide the match between their IRA and 403(b) account. As a result, you have more control over what you want to invest in with your IRA. Always take advantage of your employer match if you have one. In a nutshell, this is free money towards your retirement. Also, keep in mind that when you are investing, invest in your 403(b) account that’s equivalent to the full amount of match. Once this is done, you need to max out your IRA contributions. As a result, you have the opportunity to put money towards your 403(b) up to the fifteen percent goal.
Begin by contributing the amount that’s equivalent to the match (if you have one.
When you get a raise, increase your amount of contributions.
If you are in the process of paying off debt, increase the amount of what you currently contribute once the debt is paid.
How to Choose Your 403(b) Investments
The most obvious difference between a 401(k) and 403(b) plan is the variety of investment options that employees have to choose from. Regarding 401(k) plans, there are many ranges of investments which include exchange-traded funds, mutual funds, and even individual securities. On the flip side, 403(b) plans only have the option to invest in annuities and mutual funds.
There are very few investments to choose from when you with a 403(b) plan. However, modern-day research tells us that having multiple choices can be overwhelming. In that case, having a 403(b) is a better option.
Overall, you have two options:
- Mutual Funds
Fixed and variable unities are the two forms of annuities. With a fixed annuity, you are guaranteed a payout, just like a pension gives you. Variable annuities operate the same as mutual funds. Furthermore, your income during retirement is dependent upon how well your investments are performing in the annuity.
It doesn’t matter if an annuity is fixed or a variable. They both have fees that are higher than other investment products. On the other hand, your return on investment is more concrete. Moreover, a lifetime annuity guarantees income for life no matter how old you or your spouse may be.
Overall, always consider the fees, investment returns, annual charges associated with your investment, and the types of mutual funds & annuities when you chose to invest your money. Understanding the cash out policies is very beneficial as well.
What Are the Pros and Cons of 403b Plans?
403(b) plans (individual retirement plans) are offered to employees who work for certain organizations such as ministry, nonprofit organizations, and public schools. Most people do not have the option to invest in a 401(k) plan when they work for these of organizations. Instead, they have the option to set up sheltered annuities (403(b) plans) to save for retirement. Remember, every retirement plan (including the 403(b)) has its share of advantage and disadvantages.
The Benefits of a 403(b) Plan
403(b)s and 401(k)s are very similar to one another. They include the following:
- Matching benefits to attract and retain employees. For example, a company can match their employee’s contributions on their 403(b) dollar-for-dollar on the first 5 percent of payroll.
- The company that makes matching contributions and the employee that invest dollar-for-dollar through payroll deductions have the opportunity to write 403(b) contributions off their taxes.
- Contributing money to a 403(b) can grow tax-deferred for decades to come. This results in a significant return on investment. An individual has to pay taxes on these funds when they begin to draw from it.
- In case of emergencies, an individual holding a 403(b) can take loans against it. Also, keep in mind that you have to pay 403(b) loans back. If you don’t you will have to pay serious taxes.
Drawbacks of a 403b Account
- You only receive tax benefits if you use the money for its intended purpose. In other words, withdrawing from this account prior to retirement qualifications will give you a penalty. The penalty is equal to the taxes owed at an income tax rate that correlates to your current income tax bracket. In addition to, there is a 10 percent penalty for those who withdraw early. Once you decide to invest your money in a 403(b), your money turns from liquid cash to an illiquid asset.
- There are restrictions that come with investing in a 403(b). For instance, it’s possible that high-risk investments can’t be purchased with a 403(b).
- You can face penalties from the IRS if you invest too much money in your 403(b). The cap placed on a 403(b) limits an individual on how much of their personal savings they can deposit into a tax-deferred account.
- You have to begin making deductions of specified amounts when you are 70 ½ years old. In addition to, if you don’t withdraw like you’re supposed to, you will face serious penalties.
- Regarding beneficiaries, there are restrictions on how you can designate them on a tax-deferred account. You also have to assign a beneficiary prior to your death. Due to the account’s tax status, your beneficiary of choice may face distribution requirements from the IRS.
- Overall, you become dependent (not independent) over the use of your funds when you invest your money in an account that eligible for a specific tax status. You also must follow the IRS guidelines in order to receive what they are willing to release to you. Only choose a 403(b) if you are willing to follow these guidelines. Moreover, breaking the rules will result in penalties and financial losses on your account.