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 In case you're not familiar with the concept, a 403(b) account is a retirement savings plan, or tax shelter, for employees of tax exempt organizations, public school systems, and those of cooperative hospital services. You can generalize by saying the 403b is the nonprofit organization's equivalent of the 401k.
In this article we're going to first discuss some of the basics of the 403b plan including its benefits. Next well talk briefly about eligibility rules and the contribution limits for this type of retirement fund. Finally, we'll provide some information on some of the more frequently asked questions dealing with 403b rollovers, distributions, and loans.
403b Basics
This article will be the first in a series covering 403b plans. So we'll cover the basics here and over the coming weeks, we'll dive deeper into the details of these plans.
A 403b is sometimes referred to as a tax-sheltered annuity plan. That's because these plans started out as annuity contracts with insurance companies. Today, 403b plans are retirement plans available to certain employees of public schools and tax-exempt organizations. The 403b account can be any one of the follow types or combinations of these types:
- An annuity contract provided by an insurance company.
- An income account set up specifically for church employees or ministers.
- A custodial account, which is usually invested in mutual funds.
Benefits of a 403b
Besides the obvious benefit of a self funding retirement account, there are three additional benefits associated with 403b plans:
- Contributions to your 403b account are made on a tax-deductible basis.
- Earnings on your contributions are allowed to grow on a tax-deferred basis.
- You may be able to take a tax credit for elective deferrals made to your account.
403b Eligibility
Generally, you are eligible to participate in a 403b plan if you work for a not-for-profit organization. This type of organization is sometimes referred to as a 501(c)(3) organization, referencing the section of the Internal Revenue Service Code that defines this type of organization.
Not-for-profit organizations include employees of public schools, employees of cooperative hospitals, faculty and staff of the Uniformed Services University of the Health Sciences, and certain ministers.
Just because you work for one of these types of public companies, does not mean you can automatically open up a 403b account. Only employers are allowed to establish 403b plans.
Contributing to a 403b Account
The rules for contributing to a 403b account are very similar to those of a 401k plan. You cannot contribute to your 403b account directly; instead your money is invested by your company via deductions from your salary. Your company can also make matching contributions, or discretionary contributions, to your account.
In short, you can contribute to a 403b in three different ways - or any combination of these three ways:
- Elective Deferrals - these are tax-deferred contributions to your account using money withheld from your paycheck.
- Non-elective Contributions - these are employer contributions, which may be in the form of matching contributions, mandatory, or discretionary contributions.
- After-tax Contributions - these are contributions that you can make to your 403b account that are made on an after-tax basis.
Contribution Limits
There are limits to the amount you can contribute to a 403b plan. If you exceed these limits, then a tax penalty may apply. Generally, your 403b plan administrator can help you figure out how much you can contribute without incurring a penalty. In most situations, the plan administrator will automatically stop contributions to help you avoid a penalty.
Total Contributions
The limit in 2005 for annual additions to a 403b was the smaller of $42,000 or 100% of your includable compensation. In 2006 the limit for annual additions moved to $44,000 or 100% of your includable compensation. In 2007, this limit was $45,000, and in 2008 it moved up to $46,000. In the years 2009 and beyond, it will be indexed for inflation and move up in $1,000 increments.
Elective Deferrals
The limit on elective deferrals to your 403b was $14,000 in 2005. In 2006, this contribution limit moved up to $15,000. In 2007 the limit stood at $15,500 and it remains at that level in 2008. In the years 2009 and beyond, it will move up in $500 increments based on a measure of inflation.
Catch-Up Contributions
Finally, if you reach the age of 50 or older by the end of any calendar year, you may be eligible to make additional catch-up contributions to your 403b account. The maximum catch-up contribution you can make in 2007 is $5,000 or your includable compensation minus your other elective deferrals for the year. In 2008, the catch up contributions will remain at $5,000.
If you'd like to gain a better understanding of all the contribution rules including a discussion of the 15-Year Rule, and Maximum Allowable Contributions, then take a look at our publication on 403b contributions.
403b Contributions and Income Taxes
If your plan allows you to make an after-tax contribution, then you cannot deduct these contributions on your federal income tax return. Since your employer makes the contributions to your 403b plan on your behalf, these elective deferrals will be shown on Form W2 in Box 12. The W2 box for retirement plan will also be checked.
403b Rollovers
You can rollover a 403b account into several different types of retirement plans. This includes traditional IRAs, 401k plans, SEP IRA, and even a Roth IRA after December 31, 2007 (although you may be required to include some amounts in taxable income). You cannot rollover a 403b plan into a SIMPLE IRA.
There are two ways to perform a 403b rollover:
- Distributions to Individuals - in this situation the money from your 403b plan is distributed directly to you and you've got make sure you abide by the 60 day rule and rollover 100% of the distribution - including 20% that is withheld with a direct distribution, or you'll face some tax penalties.
- Direct Rollovers of 403b Plans - You also have the option of having your 403b plan administrator make the rollover directly to an IRA or your new 403b plan. This is by far the easiest way to conduct a rollover because the 20% withholding rule does not apply to direct rollovers. All you need to do is coordinate the exchange of the distribution.
Generally, a 403b rollover needs to be completed by the 60th day following the day you've received any distribution. There are also some other rollover rules that deal with things like frozen deposits and hardship withdrawals. To find out more information on those topics, take a look at our publication on 403b rollovers.
403b Distributions
In general, you can take a distribution from your 403b account once you've satisfied one of the following requirements:
- You've reach age 59 1/2
- You've become disabled
- You've passed away
- Your employment has been severed
- You experience a financial hardship (applies to salary reduction contributions)
If you plan on taking an early distribution you should also plan on paying any state and federal income taxes due on that distribution. Early distributions may also be subject to an additional 10% tax penalty.
Minimum Required Distributions
One of the big benefits of Roth IRAs is that there are no minimum required distributions - but that's not the case with 403b plans. You're going to need help from your plan administrator if you started your plan before 1986. But generally, you must at least take a certain amount, or possibly all, of your interest accruing in your 403b account by April 1st of the calendar year in which you become age 70 1/2 or the year you retire - whichever is later.
Once again, the tax penalties can be pretty big if you don't take the minimum required distribution from your 403b. To find out more on this topic, take a look at our article on 403b Distributions and Transfers.
403b Loans
The final topic we're going to discuss here has to do with 403b loans. Most 403b plans do allow participants to take out a loan against their 403b money; however, if the rules of the 403b loan contract are not adhered to, then the loan may be deemed a distribution. And if your not age 59 1/2, then additional tax penalties may apply.
The exact rules of a loan are established by your company and will be available through your plan's administrator. In general, the limit on all loans cannot exceed $50,000. And at a minimum, you'll need to make quarterly payments on the loan. The term, or length, of the 403b loan may not exceed 5 years and the loan must bear a reasonable rate of interest.
Borrowing Money from a 403b
Before making any decision to borrow from your 403b you need to make sure that you've exhausted all other alternatives including taking out a personal loan. You're borrowing against your future to pay for expenses today and that's not necessarily a good thing.
If you take a 403b loan you're probably going to be prohibited from participating in your plan until all of the money is repaid. And if your employer matches your contributions, then you're missing out on that benefit. If you eventually decide you cannot repay the loan then you're going to owe federal income tax and pay a 10% early withdrawal penalty.
If you'd like to learn more about borrowing against your 403b, then you can find more details about this subject in our article on 403b Loans.
Retirement Calculators
If you're wondering just how much money you should be placing in your 403b account each year, we can help there too. We've got over 75 online calculators in all, including several different types of retirement calculators. So if you want to get a better feel for how much money you need to put away for retirement each year or how much income you'll need in your retirement years, you might want to take a look at the financial planning tools we have to offer.
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