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403(b) Plan | Eligibility, Contribute Limits, Withdrawal Rules & How to Invest ?

403(b) Plan

A 403(b) plan is an excellent retirement option for people employed by nonprofit institutions. It functions much like a 401(k) plan and offers numerous advantages, including being tax-deductible and tax-free, having the option of a Roth IRA, an employer match, and various catch-up contribution limitations. To help you make the most of this account, here is a quick summary of 403(b) retirement plans, including their benefits, drawbacks, and contribution limits.

What is a 403(b) Plan ?

A 403(b) plan, commonly referred to as a tax-sheltered annuity plan, is a retirement plan available to certain public school employees, employees of certain organizations exempt from tax under Code Section 501(c)(3), and certain ministers.

Employees may contribute a portion of their salary to a 403(b) plan. The employer may also make a contribution to the employee's plan. Employees can request that their employers contribute a percentage of their wages to these retirement accounts so that no income tax is due on these earnings until the funds are subsequently withdrawn. Employees in public schools, colleges, and universities as well as those working for tax-exempt institutions like churches and charities are frequently provided access to 403(b) plans.

The maximum contribution that employees may make to their 403(b) plans is set by the IRS. When you start taking withdrawals from your 403(b), you'll be the one to start paying taxes on the money. You might also be eligible to claim the Savers Credit for contributions to your 403(b) when you file your taxes if your overall income is below a specific threshold.

Key Facts of 403(b) Plan

  • A tax-sheltered annuity plan known as a 403(b) plan is one that tax-exempt employers provide.
  • Payroll deductions are the primary method of making contributions to 403(b) plans.
  • You aren't taxed on your contributions to a 403(b) plan until you take the money out. Your investment grows tax-deferred.
  • Generally, 403(b) plans may be established by public schools, 501(c)(3) tax-exempt organizations, or churches.
  • Some employees with 15 years of employment with the same employer are eligible to make extra contributions under a 403(b) plan option.
  • Mutual funds and annuities are among the investment choices available in 403(b) plans.
  • Before withdrawing money, participants must be at least 59½ years old to avoid paying an early withdrawal penalty.
  • After turning 72, owners of 403(b) accounts are required to make required minimum distributions (RMD).
  • You can transfer the amount of your 403(b) account into a traditional IRA, if you change employment or retire.
  • If you want to buy a house but don't have enough money for a down payment, you might be able to borrow money from your 403(b) account.
  • Any outstanding sum on your 403(b) loan becomes due immediately if you leave your employment.

How Does a 403(b) Plan Work ?

A 403(b) plan is a tax-sheltered annuity plan. These retirement savings plans could be provided by employers as a perk for workers. A retirement account created for specific employees of public schools and other tax-exempt institutions is referred to as a 403(b) plan. Teachers, school administrators, government workers, professors, independent ministers, nurses, doctors, and librarians are just a few possible participants.

You can set aside a portion of each paycheck for your retirement through a 403(b) account, and if you so desire, your employer may match some of your contributions. In a tax-deferred 403(b), your contributions lower your taxable income for the current year, and you pay taxes on distributions when you retire.

For 403(b) plans, the maximum contribution in 2023 is $22,500. For 2023, the catch-up payment for people over 50 will be $7,500. The maximum combined employee and employer payments are $66,000 in 2023 or 100% of the employee's most recent annual salary, whichever is smaller. If a participant in a 403(b) plan has worked for a nonprofit organization or a government agency for more than 15 years, they may be eligible to make additional catch-up contributions.

Note :
You can contribute to both a 403(b) and a 401(k) if your employer offers them, but the total of your contributions cannot exceed the annual cap ($22,500 in 2023) excluding catch-up contributions.

Types of 403(b) Plans

Traditional and Roth 403(b) plans are the two main categories that exist. Some firms don't provide their staff members access to the Roth version.

1) Traditional 403(b) :
Pretax funds can be automatically withheld from the employee's paychecks and deposited into a personal retirement account under a standard 403(b) plan. The worker reduced his or her gross revenue while also saving some money for the future (and income taxes owed for the year). Only when the employee withdraws the money will taxes be charged on it.

2) Roth 403(b) :
In a Roth 403(b), the retirement account must be funded with after-tax dollars. There is no right away tax benefit. However, when that money is taken, the employee won't be responsible for any further taxes on it or the profit it generates.

Who can Offer a 403(b) Plan ?

A 403(b) plan may only be provided to employees by a few categories of employers. Employers who qualify must be tax-exempt organizations, including :
  • Churches
  • 501(c)(3) charitable organizations
  • Public universities or schools
  • Nonprofit hospitals

Who is Eligible for a 403(b) Plan ?

  • Employees of 501(c)(3) tax-exempt organizations.
  • Ministers (chaplains).
  • Public school systems employees (public schools, state colleges & universities).
  • Employees of churches.
  • Employees of Indian tribal governments' public school systems.
  • Those ministers who work for 501(c)(3) organizations.
  • Self-employed ministers, treated as employed by a tax-exempt organization.

Your income cannot exceed the annual limit set by the IRS, if you want to participate in a 403(b). In 2023, the maximum yearly income is $330,000.

Find out how to fix this mistake, if you've excluded eligible employees from your 403(b) plan.

What is Contribute Limits of a 403(b) Plan ?

The 403(b) plan contribution limits is the same as the 401(k) cap. According to the Internal Revenue Service (IRS), the annual contribution limit is $22,500 for 2023. Those who are 50 or older are also eligible to make a $7,500 catch-up contribution. The combined contribution limit for 403(b) plans between both the employer and employee is $66,000, including catch-up contributions in 2023.

You are also qualified for another catch-up provision, if you have been contributing into the plan for at least 15 years. You are allowed to contribute an additional $3,000 each year up to a lifetime limit of $15,000 under this provision. And unlike the typical catch-up provisions in retirement plans, you are not required to be 50 or older to benefit from this.

What Types of Contributions can be made to a 403(b) Plan ?

A 403(b) plan might allow :

1) Elective deferrals :
Contributions made by employees under a wage reduction contract. According to the agreement, an employer is free to deduct funds from an employee's pay and place them in a 403(b) account.

2) Non elective employer contributions :
contributions made by the employer that are not covered by a salary reduction agreement, such as mandated contributions, matching contributions, and some other types of contributions. On these contributions, the employee only pays income tax when the money is withdrawn.

3) Designated Roth contributions :
Deferrals made voluntarily by the employee and included in gross income. The designated Roth account's contributions, earnings, and losses must all be tracked separately by the plan.

4) After-tax contributions :
contributions made by an employee that are recorded as compensation in the year made and included in the employee's gross income for tax purposes (also known as voluntary contributions that are not designated Roth contributions).

403(b) Plan Withdrawal Rules

403(b) account holders can start taking withdrawals in the year they leave employment as long as they turn 55 or older in that same year. When making a withdrawal from a 403(b), there are a lot of rules to be aware of. Following are options of taking withdrawal from 403(b) plan :
  • Standard withdrawal
  • Required minimum distributions
  • Early withdrawals
  • 403(b) loans
  • 403(b) rollover options

Standard Withdrawal

To be eligible to withdraw money from your retirement account, you must meet one of the criteria listed below :
  • Reach age 59½
  • Become disabled
  • Have a severance from employment
  • Experience financial difficulty
  • Die (beneficiaries can make withdrawals)

The amount given to you when you withdraw money from a standard 403(b) account is taxed at your usual income tax rate. You won't owe any taxes if you have a Roth 403(b) account because you paid them in the year you made the contribution.

Required Minimum Distributions

A 403(b) account includes required minimum distributions (RMDs) starting at 72, just like a 401(k) or an IRA. The account balance at the end of the previous year and the IRS life expectancy tables are used to compute RMDs.

When participants turn 72, the majority of plan administrators will calculate and distribute RMDs to participants automatically. However, you will still be required to take the distribution and will be charged a 50% tax if you don't.

Early withdrawals

If withdrawals made prior to reaching the age of 59½, fund withdrawals are subject to a 10% penalty. If the person leaves the employer at age 55 or older, the penalty can be avoided. Under specific conditions, such as retiring at age 55 or older, incurring a qualifying medical expense, or becoming disabled, one may be exempt from this fine. In comparison to other kinds of retirement plans, plans could also offer a more limited selection of investments.

403(b) Loans

You can borrow money from your retirement assets under some 403(b) plans in order to make a significant purchase, and you can repay the loan over time (plus interest). You may borrow up to $50,000, which is equal to 50% of your account balance. For participants with less than $10,000 in their account, certain plans offer an exception that permits them to withdraw the full amount.

The loan must be repaid within five years, with payments made at least once every three months. The contributions are deducted from your paycheck in the same manner as standard 403(b) contributions. You'll be required to repay the entire amount if you leave the business without repaying the debt. If not, the remaining amount will be regarded as a distribution, and you'll be subject to tax and penalty obligations.

403(b) Plan Rollover Options

The best course of action for someone who changes employment or leaves the workforce is probably to roll over a 403(b) into another retirement plan. Although transferring money from a 403(b) account is technically a distribution, you won't be subject to an early withdrawal penalty or taxes because the money is going into another tax-advantaged retirement account. The only restriction is that any 403(b) payouts must be deposited into an eligible account within 60 days of being received. Asset transfers are frequently made automatically by a plan administrator or financial institution, which guarantees that they take place fast.

A 403(b) can be rollover or converted to an IRA, SEP IRA, SIMPLE IRA, 457(b), 401(k), or even another 403(b). Any of those plans allow you to roll over money into a specified Roth account, but unless the money comes from a designated Roth 403(b) account, you'll have to pay taxes on the entire amount. Keep in mind that only other Roth accounts may be rolled over from Roth 403(b) accounts into pre-tax retirement funds.

How to Invest in a 403(b) Plan ?

In a 403(b) plan, you will have choices over how to invest your money. You can make investments that are low, medium, or high-risk. A 403(b) plan's assets may be invested in any of the following kinds of investment :

  • A contract for annuities offered by an insurance company.
  • A custodial account with mutual fund investments.
  • A retirement income account established for church employees.

Borrowing Rules from a 403(b) Plan

There are two approaches to determine how much money is available for borrowing from a 403(b) plan. The most that the plan may authorize as a loan under IRS regulations is :
  • $10,000 or 50% of your vested account balance, whichever is larger, or
  • $50,000, whichever is less

Therefore, the maximum amount you can borrow to buy a home through a 403(b) plan is $50,000. How much you have in your plan and how much of it is vested will determine your actual limit.

You can speak with your plan sponsor to learn more about how to qualify for a 403(b) loan. You could be required by your company to submit an online loan application. The money might be deposited in a different account with the brokerage if your loan is accepted. The money may also be received as a physical check or sent to your bank account. With your plan sponsor, you can set up automatic payroll deductions for repayment.

Note :
Multiple retirement plan loans are permitted at once, but the combined balances cannot exceed $50,000.

Tax Benefits of 403(b) Plan

You can deduct contributions to a traditional 403(b) plan from your federal income taxes. The funds are deducted directly from your gross salary and put into your 403(b) plan tax-free. Based on your top marginal tax rate, this reduces the amount of income tax you owe for that year. If you choose a typical 403(b) plan, you won't have to pay taxes on your contributions until you start drawing money from the account after retirement.

Taxes on the increase in investments in your account won't be due until after you retire. The money will grow tax-free until you begin making withdrawals. With the exception of trading fees, you won't suffer any loss if you decide to change your investment strategy.

Advantages of 403(b) Plan

  • Faster fund vesting and the capacity for further catch-up contributions are two benefits of a 403(b).
  • Regular 403(b) plan earnings and returns are tax-deferred until they are withdrawn.
  • Lower administrative expenses are associated with ERISA-exempt plans.
  • Many 403(b) plans have shorter vesting periods, and some even provide immediate vesting.
  • Employees who have worked for the company for 15 years or longer may qualify for enhanced catch-up payments.

Disadvantages of 403(b) Plan

  • Earlier withdrawals are subject to a 10% tax penalty.
  • Compared to other retirement options, plans could offer a more limited selection of investments.
  • Accounts in 403(b) plans might not have the same level of protection from creditors as ERISA compliant plans.
  • Testing for nondiscrimination is not applicable to non-ERISA 403(b).

Frequently Asked Questions

Do employers have to make contributions to their employees' 403(b) plans?
No, Employers may, but are not compelled to, make contributions to employees' 403(b) plans.

Can I make IRA contributions, if I make 403(b) contributions through my work?
Yes, you may also make contributions to a Traditional or Roth IRA in addition to your 403(b) plan (b). Roth IRA contributions are subject to income restrictions.

Is a 401(k) better than a 403(b)?
Because there are more options for catch-up contributions with a 403(b), for many employees it is preferable to a 401(k). Along with their elective deferrals and any company matches, employees with at least 15 years of service can make thousands of dollars in 403(b) contributions. The same is not true for 401(k) accounts.

Who is qualify to invest in a 403(b) plan?
The employees of certain tax-exempt organizations, such as churches and charities, as well as those employed by public school, college, and university personnel, can participate in 403(b) plans, which are similar to 401(k) plans.

Can part-time employees participate?
If you typically work at least 20 hours per week, even if you only work part-time, you are eligible to join in a 403(b) plan. You must not be enrolled in any other 403(b) plans and must make an annual contribution to the plan of at least $200.

Does a Brokerage Account Option Exist in 403(b) Plans?
The only investments that are permitted under the regulations governing 403(b) plans are mutual funds and annuities. However, 403(b) plan participants are not permitted to make direct stock purchases, instead, they may invest indirectly through mutual funds.

What is the differences between a 401(k) plan and a 403(b) plan?
Employee retirement plans like 401(k) and 403(b) are similar in that pre-tax funds are used to fund them. The annual contribution ceilings are the same for both. 401(k) plans are for for-profit businesses, whereas 403(b) plans are for nonprofit businesses. This is the main distinction between the two.

Can I contribute to a 403(b) and 401(k) plan at the same time?
You may be given the option to contribute to both a 401(k) and a 403(b), if you work for two different companies, such as a private corporation and a public hospital.

Which is better a 403(b) plan or a 457(b) plan?
If you need more time to earn money to put toward your retirement, a 457(b) plan is preferable. If you desire more investment possibilities, a 403(b) might be a better option.

How can I repay the funds I borrowed from my 403(b) plan?
Paycheck deferrals are one way to pay back a 403(b) loan. According to IRS regulations, payments must be made at least quarterly. Repaying a loan is not seen as contributing to your retirement plan; however, you can do it on a separate basis.

Does using your 403(b) to borrow money impact your credit score?
Since there is no credit check necessary and these loans are not reported to credit bureaus, borrowing from a 403(b) plan shouldn't have a negative impact on your credit score.

Can employees take loans from 403(b) account?
Yes, but it's not necessary for a 403(b) plan to provide loans. Employees may, if allowed by the plan, take out loans to the extent and in the manner specified by the plan. Find out how to fix this error if any member borrowed money from the 403(b) plan and it didn't comply with the loan requirements or if the participant didn't repay the loan.

How is a 403(b) loan affected by job termination?
It might be challenging to leave a job with a 403(b) balance because the outstanding balance is required immediately. Your plan sponsor may regard the entire amount as a taxable payout and report it to the IRS on Form 1099-R if you are unable to repay the loan in full. Accordingly, you would owe income tax on the distribution in addition to any applicable tax fines.

Can employees be automatically enrolled in a 403(b) plan?
If a 403(b) plan permits employees to contribute, the provisions of the plan include an automatic contribution structure, and the employee does not opt out (affirmatively chose not to participate in the plan's automatic enrolment), then the plan may automatically enroll employees.

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