Why Save in a 403(b) Retirement Plan?
Education Next published an article in 2011 titled, “Teacher Retirement Benefits.” The author reported that many school educators and administrators in the U.S. are likely to experience a 40% to 50% drop in income when they retire, even though many are eligible to receive defined pension plan payments.
To help bridge the gap, the U.S. government has made available 403(b) plans to educators, school employees and certain nonprofit organizations since 1958. These tax-advantaged plans can help you save and supplement your pension plan for retirement.
What is a 403(b) Plan?
A 403(b) plan is an employer-sponsored, voluntary retirement savings plan. Only employees of public educational organizations and certain nonprofit organizations are eligible.
When you save in a 403(b) plan, your contributions and any growth, dividends, or earned interest will accumulate tax deferred until you withdraw funds. This is usually at retirement, at which time they are taxed only as funds are withdrawn. They are taxed generally as ordinary income. You can invest in mutual funds and annuities from approved vendors in your employer’s plan.
You can make your pretax contributions to a 403(b) plan only by a salary reduction agreement with your employer. A Kades-Margolis Financial Advisor can help you set up your plan. He or she will help you decide on your product selection, and how much you want to contribute each calendar year. Your contribution is an elective deferral.
To start a plan, you must open an account with an approved product provider under your employer’s plan and sign a salary reduction agreement. The salary reduction agreement gives your employer the authority to deduct contributions from your pay. Your employer’s third-party administrator then submits your contribution to the mutual fund company, brokerage firm or insurance company that provides you with the products in your plan.
Benefits of a 403(b)
You can make 403(b) contributions on a pretax basis which can reduce your tax bill.
Below is a hypothetical example of how pretax and after-tax contributions work. Let’s assume you are earning $40,000 annually. You are saving $100 per month in either a savings account (after-tax) or a TSA (pretax). You also are in the 25% tax bracket.
By saving $1,200 in a TSA or 403(b) account, your take home pay is $300 higher than if you saved the same amount in an after-tax savings account. Why? You made pretax contributions to your TSA. Another benefit is that the government defers the tax on the $1,200 contribution each year until you withdraw the money beginning at age 59 ½ or later in retirement. Both the contributions and any interest earned are tax-deferred until withdrawn, compounding the powerful tax advantage of a 403(b) plan.
Savings in a 403(b) plan can grow tax-deferred for decades. Once you reach age 59 ½ (or age 55 and separated from service), you may withdraw any contributions and earnings from your 403(b) account at your ordinary income tax rate.
Supplement a pension plan
While most state teacher retirement plans provide liberal retirement benefits, chances are your pension plan will not provide 100% of your current income at retirement to preserve your current standard of living. A 403(b) plan allows you to save money on a tax-favored basis. It allows you to supplement your state teacher pension plan and other savings plans.
Access through loans
If the plan sponsor allows loans in its plan, you as an account owner may be eligible to take a loan from your 403(b) plan. You must pay back the 403(b) loan, just like if you took a loan from a 401(k) plan. There are significant tax penalties if you do not.
Frequently Asked Questions
How much may I contribute to my 403(b) plan?
Effective January 1, 2015, you can contribute 100% of your compensation up to a maximum of $18,000. If you’re age 50 or more, you may contribute an extra $6,000. Maximum contribution limits may change in future years as determined by the IRS.
When can I withdraw my money in my 403(b)?
Under current tax law, you may begin withdrawals once you have reached age 59 ½ without any IRS penalties. The law requires you to begin making withdrawals once you are 70 ½, if separated from service.
If you separate from service with your employer before age 59 ½, but on or after age 55, the law allows you to withdraw your money from your 403(b) plan with no tax penalties or limits. If you separate from service before age 55, you will be subject to a 10% IRS penalty in addition to the ordinary taxes on the amount withdrawn.
What are Required Minimum Distributions (RMDs)?
When you reach age 70 ½, the IRS requires you to withdraw at least a minimum amount each year from your 403(b) plan. You will pay ordinary income taxes on the taxable portion of your withdrawal. If you don’t take your RMD, you will be charged a 50% federal penalty tax on the difference between the amount you withdrew and the amount you should have withdrawn. And you’ll still have to withdraw the required amount and pay any income tax due on the taxable amount.
When must you take RMDs?
You must withdraw your RMD for a given year by December 31 of that year. You can take the RMD either in a lump sum payment or in installments. You must take your first RMD by April 1 of the year following attainment of age 70 ½. If you decide to delay taking your first RMD until the next year, however, you’ll have to take two minimum distributions during that calendar year. This may put you in a higher tax bracket for that year, increasing the taxes you will have to pay.
May I take a loan from my 403(b)?
If your employer’s plan document allows for loans, you may be eligible to take a loan. While loan terms may vary from company to company, current regulations permit loans up to 100% of your account value up to $10,000. Or, if your loan amount is more than $10,000, the maximum loan permitted is 50% of the withdrawal value of your 403(b) account(s), not to exceed $50,000. Outstanding loans are subject to an additional interest rate charge, set by your 403(b) company. Often, the interest charged may be substantially lower than interest charged on credit cards. Check with your 403(b) provider for its specific loan rules.
Important Note: Under current regulations, the borrower must repay the loan in at least quarterly installments of principal and interest. The period may not exceed five years, unless the loan’s purpose is to buy a principal residence, in which case you may extend the repayment period beyond five years.
What savings and investment products are available in a 403(b) plan?
If you are eligible to take part in a 403(b) plan, you may choose among different types of investments. You can select a 403(b) provider from the list of approved providers under your employer’s 403(b) plan. Kades-Margolis offers a retirement program for PSEA members – Money by Design. This program offers members a customized 403(b) plan. Money by Design offers you more than 400 mutual funds, representing more than 20 fund families. The program allows you move between funds, fund families and a fixed-interest annuity option at no extra charge.
Working with a financial advisor may help you choose investments that best meet your financial objectives, based on your personal investment objectives and risk tolerance. You should consider the investment objectives, risks, and charges and expenses of the funds offered carefully before investing.
Are there costs involved with changing my investment choices?
Depending on the type of account you have and your account provider, there may be fees charged if you withdraw or transfer your account. Your financial advisor will discuss these fees with you, if applicable. For example, if you withdraw money from a variable annuity within the first few years, the insurance company may assess a “surrender” charge. The surrender charge is a percentage of the policy’s accumulation value. The percentage typically declines gradually over several years.
Also, some mutual funds have a back-end sales load known as a “contingent deferred sales charge”. Like a surrender charge for a variable annuity, the amount of this load will depend on how long you hold the mutual fund shares. This load typically decreases to zero if the investor holds the shares long enough. The fund’s prospectus will show the rate at which this fee declines.
A redemption fee is another fee that some companies charge shareholders when the shareholders redeem their shares. Unlike a sales load, a redemption fee defrays costs associated with redemption. The Securities Exchange Commission (SEC) limits redemption fees to 2%.
Further, you may be subject to tax penalties if you take an early withdrawal from your 403(b). Your financial advisor can help you determine if you will be subject to any early withdrawal penalties.
What other fees will I pay?
Fees and expenses vary from product to product. An investment with high costs must perform better than a low-cost investment to produce the same returns for you. Even small differences in fees can mean large differences in returns over time. For mutual funds and variable annuities, you can find information on costs and fees in the prospectuses. For annuities, check the sales literature or the contract.
Separation from Service
When you’re cleaning out your classroom and packing up boxes for a career change, new district or retirement, remember to pack up your 403(b) savings as well. Making the decision to retire, or making a transition from job to job, no matter the reason, can be stressful. Sometimes the last thing you want to worry about is the money in your 403(b). By taking educated steps, you can ensure that your retirement money remains in your control.
When you separate from service, you have the option to rollover your account into an IRA or into an approved retirement account without an IRS penalty. Depending on your own personal situation, this may be a better option than withdrawing your account and taking a lump sum payment. It is important to discuss your options with your financial advisor to help make the best decision for your situation.
If you would like more information about a 403(b) plan, please call
Kades-Margolis at (800) 433-1828, ext. 4, or click this link, fill out the form and send. We will have one of our financial advisors contact you.