Were you recently offered the opportunity to enroll in a 403(b) plan? Or maybe the option has been on the table for awhile but you haven’t gotten around to entertaining it until now. Either way, you may be uncertain with regards to how they work and if they’re ideal for your financial situation and fit in with your retirement planning strategy.
But don’t fret. Read on to learn more about the ins and outs of 403(b) plans.
What Is a 403(b) Plan?
Also referred to as a tax-sheltered annuity plan, a 403(b) plan is “a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers,” according to Publication 571 from IRS.gov.
The entity offering the 403(b) plan, whether it’s a school, non-profit, ministry, or governmental organization, will pre-select the structure of the plan. But you’ll be allowed to select from a pool of investment options, typically mutual funds, that are aligned with your risk tolerance and best suit your investment needs.
There are three types of accounts that can be housed in a 403(b) plan: an annuity account from an insurance company, a custodial account invested in mutual funds, or a retirement income account exclusive to church employees, Publication 571 adds.
How 403(b) Plans Work
When initially enrolling in a 403(b) plan, you’ll be asked how much in contributions you’d like to make. In most instances, the funds are deducted from your earnings each time you’re paid and will appear on your pay stub as pre-tax deductions. You should also know that there’s a cap on the amount you can contribute to your 403(b) each year. More on that shortly.
To illustrate, if you’re pre-tax earnings are $1750 and you wish to contribute 5 percent to your 403(b) plan each time you’re paid, your employer will deduct $87.5 and allocate the funds to your retirement account.
You’ll enjoy tax savings on earned income since contributions are pre-tax. This means that they reduce your taxable income, which in turn reduces your tax liability. But when you begin making withdrawals, the proceeds will be subject to taxation.
This is particularly beneficial if you anticipate being in a lower tax bracket due to decreased taxable income at retirement. But if your income increases drastically, it may be better to contribute to a Roth IRA plan where you make post-tax contributions, instead. (Bonus tip: your employer may also offer a Roth option of the 403(b) plan, so inquire with your plan administrator if it seems like a better fit).
Most importantly, your money will have a chance to grow on its own due to compounding interest that allows you to earn interest on top of interest. And the more you contribute over time, the larger your nest egg will be.
Annual contributions to 403(b) plans are capped at $19,000 for 2019, compared to $18,500 for 2019. But if you’re 30 years of age of older, the IRS permits catch up contributions of $6,000 annually for 2019. So, you’ll be able to contribute up to $24,500 this year if you meet the age criteria.
Wanting to contribute even more? According to Publication 571, additional contributions may be permitted if you’ve been employed for 15 years or more in a public service capacity with select entities. These include churches, home health agencies, hospitals, public or private schools, and welfare agencies.
To confirm your allowable annual contribution limits, consult with your plan administrator.
When Can You Withdraw Funds from Your 403(b)?
Once you’re 59 ½ years of age, you can elect to take penalty-free withdrawals. However, they will be subject to federal income tax since contributions were made pre-tax.
While there’s no pressure to start taking withdrawals right away, you’re legally obligated to do so by the time you’re 70 ½ years of age. These are referred to as Required Minimum Distributions (RMDs) and are computed by the federal government. Failing to adhere to this rule could result in a nondeductible excise tax of 50 percent on the amount that falls short of the amount that is distributed and the minimum amount required by law.
If you wish to access your funds early, you have every right to do so. However, you will incur a 10 percent penalty on top of the personal income tax owed on the funds.
Are 403(b) Plans Transferable?
Wondering if you’ll automatically lose the funds in your 403(b) plan if you leave your job? Not quite. The amount you contribute is always your to keep, but will need to be rolled into an IRA if you wish to continue making contributions. Why so? Well, the 403(b) plan can be kept intact and continue earning, but you won’t be permitted to contribute more money to it.
What about the amount the employer contributes on your behalf (if applicable)? You can only carry those funds with you if you’re vested, which means you’ve held a position with the employer for a set amount of time.
Should You Contribute to a 403(b) Plan?
If your employer is offering to match your contributions by up to a certain amount of your income, contributing to their 403(b) plan is a no-brainer. Otherwise, you’ll be leaving free money on the table. But if there aren’t very many incentives, alternatives that are available outside of your employer may be worth exploring
What about the monthly contributions? How much is ideal? While you can’t exceed the annual contribution limits, you have to consider your retirement goals and how much money for the duration of your working life is it going to take to get there. It’s a good idea to sit down with a representative of your plan administrator to hash out the details. You may find that even with maximum contributions each year, it’s still necessary to supplement your efforts with another retirement vehicle.
Also, consider your current financial situation. While it may seem ideal to sock away as much as possible into your 403(b) account, it may be more sensible to scale back contributions to build an emergency fund or address high-interest debts. Doing so can give you a solid financial foundation and the opportunity to contribute even more to your nest egg later on down the line. And although this approach could mean you’ll forfeit earnings, the risk of doing even more damage to your finances is substantially lower.
How to Open a 403(b) Account
To open a 403(b) account, consult with your plan administrator to determine the next steps. They may allow you to do so online or arrange for a representative to come out and meet with you during a time that’s convenient for you.
Other Retirement Planning Tips
Regardless of which type of retirement plan you decide to go with, always consult with your plan administrator or reputable financial adviser before making decisions. Some other tips to help ensure you reach your savings goals:
Take Advantage of Compounding Interest
Don’t overlook the power of compounding interest. Instead, contribute as much as you can without stretching yourself too thin to give yourself the best chance at knocking your retirement goals out of the park.
Review and analyze your accounts on a consistent basis. It may be necessary to make adjustments to your portfolio and investment strategy frequently.
Avoid Early Withdrawals
Refrain from taking early withdrawals unless it’s an absolute financial emergency. But if you ignore this advice and take away funds for a non-essential reason, you will not only incur penalties but could be robbing your future self by diminishing the value of your nest egg.
The Bottom Line
A 403(b) plan is a viable option to build your nest egg. But as with any investment product, you want to remain vigilant of your portfolio’s performance at all times and make adjustments as needed to ensure you meet your retirement goals in a timely manner.