What to Know About 403(b) Plans

If you work for the public school system or a tax-exempt, nonprofit organization, such as a church or charitable organization, you may have a 403(b) retirement plan. But are you taking full advantage of its benefits? Do you fully understand all of its pitfalls? In this article, we will take a look at this tax-deferred retirement savings option to find out:

  • What 403(b) plans are
  • Investment options within these plans
  • How to know if you qualify for a 403(b) plan
  • The contribution and withdrawal requirements for them

403(b) Retirement Plans Defined

In simple terms, 403(b) plans are employer-sponsored, tax-deferred retirement plans. Just as with their cousin 401(k) plans, your contributions and their gains will accumulate tax free until the time of distribution. Most often, eligible employees can invest these 403(b) retirement savings in mutual funds or annuities. If a plan participant elects to make contributions, the money contributed may not be counted in the employee’s gross income for that year, which could reduce current income taxes owed.

Keep in mind there are different types of 403(b) plans. They typically fall into three broad categories:

  • Annuity contracts from insurance companies
  • 403(b)(7) plans are custodial accounts made up of mutual funds
  • 403(b)(9) plans are retirement income accounts for church employees, typically invested in mutual funds and annuities

You may also be able to choose a Roth 403(b) in which contributions—like those in a Roth IRA—are made with after-tax income and the funds grow free of capital gains taxes. However, unlike the Roth IRA, if you withdraw from your 403(b) before age 59.5, you will have to pay a penalty in most cases.  

403(b) Plan Investment Options 

A 403(b) plan is often referred to as a Tax-Sheltered Annuity (TSA), because for many years, annuities were the only investment option available in this type of plan. But that has changed and some 403(b) plans now permit the purchase of mutual funds and other investments. Many 403(b) plans are still invested in either fixed or variable annuities though.

Another popular option for 403(b) plans is Guaranteed Investment Contracts (GIC). These contracts are also issued by insurance companies and offer a guaranteed return of principal at a future date. These contracts are similar to a bank certificate of deposit (CD), but the fixed rate of return may be higher.

Eligibility Requirements

To qualify for a 403(b) plan, you must be an employee of a public educational institution, a 501(c)(3) tax-exempt organization or church organization. 503(c)(3) organizations—corporations, trusts or other types of organizations exempt from federal income tax—are eligible to establish 403(b) plans. Some examples of 503(c)(3) organizations are private colleges, trade schools, zoos, research and scientific foundations, religious or charitable institutions and private hospitals and medical schools.

Since the organizations that offer 403(b) plans are often non-profit organizations, 403(b) there is no profit sharing component from the sponsoring employer. Opposite to their cousin 401(k) plans, not all 403(b) plans are required to comply with the Employee Retirement Income Security Act (ERISA). Those plans that are non-ERISA qualified may not be able to process account distributions, approve loans or authorize transfers to other accounts. Be sure to understand whether your employer’s plan is subject to ERISA requirements or not.

403(b) Contributions

Most 403(b) contributions are pre-tax amounts taken from your salary. Since 403(b) plans are defined contribution plans, investors should know how much of their savings they are putting into the plan. For 2020, the maximum annual contribution was raised to $19,500, plus $6,500 in catch-up contributions for those over age 50. If your employer matches your contributions, the amounts will typically match a defined percentage of your contributions.

403(b) Distributions

In cases where employee contributions are made with pre-tax dollars, all earnings—interest, capital gains and dividends—will grow tax deferred. But any distributions you take will be subject to ordinary income tax rates. If you make a withdrawal from your 403(b) before age 59.5, a 10% penalty will apply unless the distribution has a waiver. Distributions that would qualify for a waiver include, the purchase of a primary residence, higher education expenses for you or your immediate family, medical expenses for you or your family, if you are permanently disabled or if you are court ordered to pay money to the account of a spouse.

Another consideration is that you must start making required minimum distributions (RMDs) by April 1 in the year in which you reach age 72. Note: If you turned 70 ½ in 2019 or before you are required to begin taking required minimum distributions at age 70 ½. Once your RMDs begin, you must make annual withdrawals by December 31 each subsequent year. You may be able to estimate your RMD amount, but a tax advisor should be able to provide the exact amount you will need to withdraw from your account each year.

How Fisher Investments Can Help

Although you may have started investing in a 403(b) plan sponsored by your employer, the plans can still be complicated and it’s important to understand the details of your plan. Since many 403(b) plans invest in annuities, you should have a complete understanding of how your plan is structured and whether there are other options available to you. With other investment options potentially available, you want to ensure your hard-earned retirement savings are working to meet your longer-term goals.

Call Fisher Investments to speak with one of our professionals or download one of our educational investing guides to learn more!

The contents of this webpage should not be construed as tax advice. Please contact your tax professional.

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