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 pretax or Roth salary deferrals.1

403(b)s are retirement savings plans that allow employee contributions to grow tax-deferred or tax free1 until withdrawn at retirement.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(c)(3) 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 directly from your paycheck. With traditional tax-deferred investing, you can contribute on a pretax basis and your contributions and earnings grow tax-deferred. Over time, 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your retirement account with income that’s already been taxed, and contributions and their investment earnings can be withdrawn tax free.1

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.

Why a 403(b) Is a Smart Option

  • Tax-deferred and tax free growth are the primary advantages of a 403(b) retirement savings vehicle. Contributions on a pretax basis are tax deductible and deferred until you begin withdrawals. Roth contributions grow tax free, provided certain conditions are met.* With a Roth you pay taxes on the contributions up front.
  • Contributing to a 403(b) is simple – 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, time horizon and risk tolerance.
  • Investing a fixed dollar amount regularly over a long period of time allows you to purchase more mutual fund shares when prices are low and fewer shares when prices are high. This process is called dollar cost averaging.2 Over the long run, it helps reduce the effects of market volatility on your share purchases as the average cost per share is lowered over time. In essence, you’re making the market’s ups and downs work for you.

*Distributions from a Roth are tax and penalty free provided the account has been held five years or more and a qualifying event is experienced.

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. The limits are adjusted annually for cost of living increases. You may contribute the lessor of 100% of your compensation or $18,000 in 2016. In addition, the tax law provides an added savings incentive for participants age 50 or over, permitting them to make annual “catch-up” contributions. The catch-up amount is $6,000 in 2016.

Additionally, 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 distributions 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 1 of the year after you reach age 70½ or retire, whichever is later. These distributions are commonly referred to as required minimum distributions (RMDs).

Thereafter, 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 $1,500. Your plan’s loan provisions may vary.

For more information on 403(b) plans, talk to your
financial or tax 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 automatic investment 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 employer or financial or tax advisor to see if you qualify for the special 15 years of service catch up provision.