What Is a 403(b) Plan?
The 403(b)/Tax-sheltered annuity (TSA) plan was created for employees of public school systems, colleges, universities, churches and tax-exempt non-profit organizations to encourage retirement savings. Like the 401k, the purpose of a 403(b) is to provide employees with a tax-advantaged method of saving for retirement from one of these eligible employment categories by allowing them to contribute pre-tax dollars (by deferring part of their salary) into the plan.
How a 403(b) Retirement Plan Works
Employees can elect to contribute a portion of their salary into a 403(b) Plan through salary reduction. Most contributions to a 403(b) Plan are made on a pre-tax basis, so there is a tax benefit for contributing to the plan because you reduce your taxable income in the year you make your contribution. Some employers also have a Roth 403(b) option available, where contributions are made with after-tax income, and are tax-free to access at retirement.
The funds in a 403(b) Plan grow tax deferred, meaning you generally will not owe tax on the earnings while they are in the plan until you take a distribution from the plan.
What Happens to a 403(b) When You Retire?
403(b) Plan Distributions
Retirement or qualification for plan distributions will allow you access to various options provided by your employer’s 403(b) plan, particularly as they relate to various IRS rules and regulations. These options include both:
- Lump-sum distribution(s): You can withdraw your total available account balance as one payment. This option is a good way to quickly access your funds, but you will incur tax liability immediately and possibly incur a higher effective rate of federal tax than if you had withdrawn through scheduled payments.
- Scheduled periodic or periodic distributions: Many retirees choose to withdraw an established dollar amount on a scheduled basis (monthly, quarterly, annually) or percentage of their available account balance. While scheduled withdrawals as stated above do not provide you with the full balance of your 403(b) plan as quickly as a lump sum withdrawal, they allow for the continued receipt of retirement income at an established frequency during
In addition, any distribution (lump-sum or periodic) prior to age 59½ may be subject to an additional early distribution penalty of 10%, unless an exception applies to you under the applicable IRS regulations.
403(b) vs. 401(k): What’s the Difference?
The key difference between these two types of plans is in the entity providing them.
The 403(b) plan is only available to employees of tax exempt organizations, such as public schools.
In contrast, the 401(k) plan is available to employees of for-profit companies.
Contribution limits and tax treatment are similar for both types of plans but there may be differences in terms of the types of investments available as well as special catch-up provisions that may apply to long-serving employees who are able to take advantage of these benefits.
How Much Should You Contribute to a 403(b)?
Annual contribution limits are determined by the IRS, but your contributions depend on your individual finances, retirement objectives, and employer benefit package. Many financial professionals suggest saving 10%-15% of your income toward retirement as a general guideline to meet these objectives, including (but not limited to) 403(b). Additionally, if your employer provides matching contributions, contributing enough to meet the matching contribution threshold will greatly increase your ability to reach your retirement target.