A 403(b) plan is similar to a 401(k) plan in that it's an easy way to save for retirement and benefit from pre-tax or Roth salary deferrals1.

403(b)s are retirement savings plans that allow employee contributions to grow tax deferred or tax free1  until withdrawn at retirement. The plans are designed for employees of eligible tax-exempt organizations, including:

  • Public education institutions - elementary and high schools, colleges and universities
  • Churches or church-related organizations
  • 501(3)(c) tax-exempt organizations, such as
    • Nonprofit hospitals
    • Social and welfare organizations
    • Museums and others

Sometimes called tax-sheltered annuities or tax-sheltered custodial accounts, 403(b)s are offered through your employer and the contributions you make  come out directly from your paycheck. With traditional tax-deferred investing you can contribute on a pre-tax basis and your contributions and earnings grow tax-deferred.  Overtime, this tax-deferred compounding can have a dramatic impact on your retirement savings.

The Roth feature offered by some 403(b) plans lets you fund your retirement account with income that’s already been taxed, and withdraw all these dollars and their investment earnings tax free1

Why a 403(b) is a Smart Option

  • Tax-deferred and tax-free growth are the primary advantages of a 403(b) over other savings vehicles. Tax-deferral on income and earnings generated by your account allows your account to grow faster.
  • Contributing to a 403(b) is fairly painless - the money is taken out of your paycheck before taxes, so you never even see it to miss it.
  • A 403(b) plan gives you control over your retirement plan by letting you choose from a variety of investments that may match your goals.
  • Investing regularly over a long period of time allows you to purchase more mutual fund shares when prices are low and fewer when prices are high. This process is called dollar cost averaging.2 Over the long run, it reduces the effects of market volatility on your share purchases. In essence, you're making the market's ups and downs work for you rather than against you.

Contribution Limits
The Internal Revenue Service cost-of-living adjustments (COLA) affect contribution and other limits that may play a key role in an investor’s financial plan. You may contribute the lessor of  100% of your compensation or $17,500 in 2014. These limits may be increased for cost of living adjustments. You may choose to make both traditional (pretax) and Roth (after tax) 403(b) contributions, however, the combined total cannot exceed the maximum limits described here. Also, the tax law provides an added savings incentive for participants age 50 or older, permitting them to make annual "catch-up" contributions. The catch-up amount is $5,500 in 2014. 

On top of that, a special rule for 403(b) participants allows certain employees with 15 or more years of service to contribute up to an additional $3,000 from their salary, for five years.3

Taking Distributions
You can begin taking normal distributions from a 403(b) plan at age 59½. A distribution taken before age 59½ may be subject to a 10% penalty. In addition, the IRS requires an automatic 20% withholding for federal income taxes from distributions that are not directly rolled over to another qualified retirement plan or IRA. All withdrawals are taxed as ordinary income in the year received.

The exceptions to this rule are that you may take an early distribution penalty free if you separate from service and are at least age 55 in the year of separation or if the distribution is taken as part of a series of approximately equal payments, or if you become disabled or die. Remember, though, that you must begin taking distributions by April 1st of the year after you reach age 70½ or retire, whichever is later. These distributions are commonly referred to as required minimum distributions (RMDs).

After that, you must take distributions annually by December 31. If you don't take the RMDs on time, the IRS will assess a penalty of 50% of the amount that should have been withdrawn.

Taking a Loan From a 403(b)
Although permitted, not all plans offer loans. Generally, you may borrow up to half of your vested account balance to a maximum of $50,000 without tax consequences as long as the loan is paid back within five years (unless it is for the purchase of a home, in which case the loan period may be extended). In general, the minimum loan allowed is $1,000. Your plan’s loan provisions will vary.

For more information on 403(b) plans, talk to your financial advisor today.

1 The Roth feature must be offered by the plan. Roth deferrals have already been taxed and grow tax free provided they are held for five years and a qualifying event occurs. 

2 Since such plans involve continuous investments regardless of price levels of fund shares, investors should consider their financial ability to continue purchases through periods of low price levels. Systematic investment plans such as dollar cost averaging do not guarantee profit or protect against loss in declining markets.  Before investing, investors should evaluate their long-term financial ability to participant in such a plan. 

3 Please contact your financial or tax advisor to see if you qualify for the special 15 year catch up provision.


This material is provided for general and educations purposes only, and is not intended to provide legal, tax or investment advice, or for use to avoid penalties that may be imposed under U.S. federal tax laws.  Contact your attorney or other advisor regarding your specific legal, investment or tax situation. 

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