A Guide to the 403(b) Retirement Plan

February 01, 2022 · 7 minute read

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A Guide to the 403(b) Retirement Plan

If you work for a nonprofit, you typically have access to a 403b plan rather than a 401(k). There are some differences between the two, but like a 401(k), a 403b is one of the easiest and most effective ways to start saving for your golden years.

This article dives into the nitty-gritty details of 403b plans, also known as tax-sheltered annuities or TSAs. What are they, how do they work, and who is eligible?

What Is A 403(b) Retirement Plan?

The 403(b) retirement plan is a type of qualified retirement plan designed to help employees save for retirement. Certain schools, religious organizations, hospitals and other organizations often offer this plan to employees. (In layman’s terms: it’s the 401(k) of the nonprofit world.)

Like 401(k)s, 403(b) plans allow for regular contributions toward an employee’s retirement goal. Contributions are tax-deductible in the year they’re made. Also, you won’t pay taxes on any earnings in the account until you make withdrawals.

However, unlike 401(k)s, 403(b)s sometimes invest contributions in an annuity contract provided through an insurance company rather than allocate it into a stocks-and-bonds portfolio. A custodial account may also use the funds to invest in mutual funds.

403(b) Rules

Like other retirement plans, 403(b)s have limits on how and when participants can take distributions. Generally, account holders cannot touch the funds until they reach age 59.5 without paying taxes and a penalty. Furthermore, required minimum distributions, or RMDs, apply to 403(b) plans and kick in at age 72.

Who Can Participate in a 403(b) Plan?

Only employees of specific public and nonprofit employers are eligible to participate in 403(b)s, as are some ministers. You may have access to a 403(b) plan if you’re any of the following:

•  An employee of a tax-exempt 501(c)(3) nonprofit organization

•  An employee of the public school system, including state colleges and universities, who is involved in the day-to-day operations of the school

•  An employee of a public school system organized by Indian tribal governments

•  An employee of a cooperative hospital service organization

•  A minister who works for a 501(c)(3) nonprofit organization and is self-employed, or who works for a non-501(c)(3) organization but still functions as a minister in their day-to-day professional life

Employers may automatically enroll employees in a 403(b), though employees can opt out if they so choose. Of course, participating in an employer-sponsored retirement plan is one good way to start saving for retirement.

How Much Can You Contribute to a 403(b)?

In 2022, workers can put up to $20,500 into a 403(b) plan without paying taxes on it. Workers who’ve been with their employer for 15 years may be able to contribute an additional $3,000 and those age 50 or older can contribute an additional $6,500.

You can contribute to your 403(b) through automatic paycheck deductions. This process is similar to how it works with a 401(k)—the employee agrees to have a certain amount of their salary redirected to the retirement plan during each pay period.

However, other types of contributions are also eligible, including:

•  Nonelective contributions from your employer, such as matching or discretionary contributions

•  After-tax contributions can be made by an employee and reported as income in the year the funds are earned for tax purposes. These funds may or may not be designated Roth contributions. In this case, the employer needs to keep separate accounting records for Roth contributions, gains, and losses

How Are 401(k)s and 403(b)s Different?

One notable difference between 403(b) plans and 401(k) plans is there is no profit sharing in 403(b)s—workplaces that are 403(b)-eligible aren’t working toward a profit.

How Much Should You Contribute to a 403(b) Plan?

If your employer offers a match, you should aim to contribute at least enough to get the full match. Not doing so is like leaving free money on the table.

Beyond that, many financial advisors suggest shooting to save at least 10% of your income for retirement, but you may be able to save less if you have access to guaranteed retirement income such as a pension, as many teachers do.

Recommended: Explaining the 3-Legged Stool of Retirement

If 10% seems like an unreachable goal, contribute what you can, and then consider increasing the amount that you save each time you get a raise. That way, the higher contribution will not put as much of a dent in your take-home pay.

Doing some calculations to figure out how much you need to save and when you can retire can help you determine the best amount of save.

Recommended: How to Save for Retirement

What Types of Investments Go in 403(b) Plans?

One way 403(b) plans diverge from other retirement plans, like 401(k)s and even IRAs, is how the organization invests funds. Whereas other retirement plans allow account holders to invest in stocks, bonds, and exchange-traded funds, 403(b)s commonly invest in annuity contracts sold by insurance companies.

Part of the reason these plans are known as “tax-sheltered annuities” is that they were once restricted to annuity investments alone—a limit removed in 1974. While many 403(b) plans still offer annuities, they have also largely embraced the portfolio model that 401(k) plans typically offer.

Can You Borrow Against 403(b) Plans?

There are rules that limit how and when the account holder can access funds in a 403(b) account. Generally, employees (or their beneficiaries) can’t take distributions, without penalties, from their 403(b) plan until they reach age 59 ½.

However, some 403(b) plans do allow loans and hardship distributions. Loan rules vary by the plan. Hardship distributions require the employee to demonstrate immediate and heavy financial need to avoid the typical early withdrawal penalty.

As with other retirement accounts, distributions taken outside of the permitted limits incur a 10% early distribution penalty on top of regular income taxes that are still owed on the money.

What Are 403(b) Plan Requirements?

The IRS states that a 403(b) plan “must be maintained under a written program which contains all the terms and conditions.” In other words, for the plan to be legitimate, paperwork is required.

However, this paperwork may not necessarily be a single document so that an employee may get a whole packet of information as part of the onboarding process. This package can include salary reduction agreement terms, eligibility rules, explanations of benefits, and more.

In certain limited cases, an employer may not be subject to this requirement. For example, church plans that don’t contain retirement income aren’t required to have a written 403(b) plan.

Who Doesn’t Qualify for 403(b) Plan Participation?

Employers must offer 403(b) coverage to all qualifying employees if they offer it to one, known as “universal availability.” However, plans may exclude certain employees, including those under the following circumstances:

•  Employees working fewer than 20 hours per week

•  Employees who contribute $200 or less to their 403(b) each year

•  Employees who participate in retirement plan, like a 401(k) or 457(b) of the employer

•  Employees who are non-resident aliens

•  Employees who are students performing certain types of services

However, the same laws that allow these coverage limits also require employers to meet non-discrimination standards. They require employers to give employees notice of specific significant plan changes, like whether or not they have the right to make elective deferrals.

Can Employers Terminate 403(b) Plans?

An employer has the right to terminate a 403(b), but they’re required to distribute all accumulated benefits to employees and beneficiaries “as soon as administratively feasible.”

Employees may be eligible to roll their 403(b) funds over into a new retirement fund upon termination.

Saving for Retirement Without a 403(b) Plan

Even if an employee doesn’t have access to an employer-sponsored account, there are other ways to save for retirement. For instance, IRAs are a popular option among the self-employed and freelancers, who can use their tax benefits to help get a leg up on their retirement savings.

IRAs come in various options, but the two most common for individuals are Roth and traditional—with after-tax and pre-tax contributions, respectively. (In other words, you pay taxes on funds contributed to a Roth before they go into the account, whereas you pay taxes on funds contributed to a traditional IRA after you take the distribution.)

While the tax incentives and special early distribution rules built into retirement-specific accounts are attractive, the primary motivator for most retirement investors is the power of compound interest. By regularly contributing to an investment account and maintaining fund allocation account holders could see an exponential amount of growth over time.

Recommended: 4 Places to Put Your Retirement Money

The Takeaway

If you work for a nonprofit employer, contributing to a 403(b) is a great, tax-efficient way to start saving for retirement. The earlier you can start saving for retirement, the more valuable your contributions will be over time, thanks to the magic of compound interest.

If your employer does not offer a 401(k), or if you’re interested in additional ways to save or invest for retirement, opening an online retirement account could be a good solution. Along with regular investment accounts, SoFi also offers a range of retirement account options, including both Roth and traditional IRAs.

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