What are 403(b) plans and how do they work?
Most of the time, the spotlight is on the 401(k) plans.
A 403(b) plan is equally important though. It’s just aimed at a different group of employees.
When a company hires you, one of your very first tasks as a new employee is deciding upon a retirement savings plan.
Some companies don’t offer you much of a choice. So the paperwork you’d have to handle is merely a standard formality.
Other companies though make sure to keep you busy thinking about which retirement savings option would be best.
So, where does a 403(b) plan stand?
What is a 403(b) plan and how does it work
A 403(b) account is a tax deferred retirement savings plan for organizations, tax-exempt under IRS Code 501(c)3.
Don’t let the fancy talk confuse you!
It means 403(b) plans are designed for teachers, professors, librarians, government employees, hospital and non-profit employees organization.
From a tax point of view, a 403(b) plan is very similar to a 401(k) account.
They’re both tax deferred. This means your contributions are not subject to tax, but you’ll have the ‘honor’ of paying your taxes on this money once you retire and start withdrawing.
In some cases, employers may allow you to contribute to a Roth 403(b) as well. In which case, you’ll pay taxes as you deposit you money and withdraw your funds tax-free once retired.
Related article: Living frugally on a low retirement income
Just like 401(k) plans, the maximum amount you’re allowed to contribute to a 403(b) is – you guessed it! – $18,000 a year, with a $6,000 increase after age 50 (so, $24,000 a year can go straight into your retirement savings).
In addition, if you don’t switch jobs and remain a loyal employee for at least 15 years, you can add $3,000 to top off your contributions.
This brings your retirement savings plan to a total of $21,000 /year for those under 50 years old, and $27,000 for loyal employees over age 50.
Employees can match your contributions for a 403(b) plan as well, so there’s no need to be jealous of fellow 401(k) contributors!
Not everyone does it though, but it’s nice to know the possibility exists.
Related article: Are you saving enough for your retirement?
403(b) investment options
All contributions are then immediately invested. It’s like having your own investment portfolio that someone else takes good care of.
With a 403(b) plan, your investment options include mutual funds and annuities.
The good news is you have a retirement account in place that will hopefully bulge up into a nice nest egg.
The bad news is your investment options are limited to the 2 choices alone. If you were hoping to diversify your investments with stocks or bonds, you’d have to figure out a way to invest on your own.
Related article: Investing basics: comparing stocks, bonds and mutual funds
Withdrawing from a 403(b)
At 59 and 1/2, you can safely start withdrawing money from your 403(b) plan.
Start withdrawing early and you’ll have to pay a 10% penalty on the amount you took out of your account. This is in addition to the taxes owed (since your initial contributions were tax free).
There is a way, however, to avoid the 10% penalty fee for early withdrawal, starting at age 55.
It’s not a loophole, so don’t start cheering just yet!
You may avoid the tax penalty if you have certain medical expenses to take care of. Or if you, knock-on-wood, become disabled. Or die (in which case your beneficiaries will withdraw the money penalty fee free).
On to more positive news, you can also avoid paying a penalty fee if you stopped working for your employer once you turned 55.
Withdrawing from a 403(b) isn’t mandatory, unless you turned 70 1/2. Once you blow 70 and a half candles on your birthday cake, you must start withdrawing your money (and why wouldn’t you? It’s your money!)
Related article: Alternative ways to save for retirement without a 401(k)
What if you decided to stop teaching and pursued a different career?
What happens to your retirement savings account?
You can roll over your 403(b) plan into a different retirement savings plan!
If you start working for an employer that offers 401(k), SEP or 457 plans, you can roll your old account over and continue making contributions to your new retirement plan.
You’ll have to find an alternative if your new employer doesn’t offer any of these.
The good news though, is you can always roll over a 403(b) over to a traditional or Roth IRA.
If you decide to go the self employed route, you can safely roll over your 403(b) into a Solo 401(k) plan.
Whatever you choose, avoid cashing our your 403(b). Even if your contributions weren’t much, it’s still advisable to let your retirement funds grow, instead of cashing them out and losing 10% of your money on top of it all.
Related article: Retirement saving options for the self employed
Do you ave a 403(b) or know anyone who does?
How does this particular retirement savings plan compare to the more ‘traditional’ ones?