A 403(b) plan is a tax-sheltered retirement plan for people who work for nonprofit companies, including charities, schools, and qualified religious organizations. The 403(b) plan is comparable to its private-sector counterpart, the 401(k) plan, with important differences.
If you're considering enrolling in a 403(b) plan, check out the benefits below.
- The 403(b) plan is similar to the 401(k) plan available for private-sector employees.
- If your employer offers it as an option, you may have a choice of traditional or Roth.
- A feature unique to 403(b) plans allows some employees with 15 years of service at the same employer to make extra contributions.
Tax-Deductible and Tax-Free
Contributions to a traditional 403(b) plan are deductible on your federal income taxes. The money comes out of your gross salary and goes directly into the 403(b) plan, untaxed.
This cuts down on the income tax you owe for that year based on your top marginal tax rate. For example, if the last $10,000 of your adjusted gross income is taxed in the 22% tax bracket, placing $10,000 into a 403(b) would save you $2,200 in taxes.
If you opt for a traditional 403(b) plan, you don't pay taxes on the money you pay in until you begin making withdrawals after you retire. And remember, most people fall into a lower tax bracket after retirement.
It's important to note that you won't owe taxes on the investment growth in your account until after you retire. The money will grow tax-free until you begin making withdrawals.
You will be able to change your investment choices without losing much, except for some trading fees. And because the tax efficiency of your mutual funds isn't a concern, you can concentrate your portfolio on investments that offer high returns and low expenses.
The Roth Alternative
Since 2006, participants have also had the ability to choose a Roth rather than a traditional 403(b) plan. If you opt for a Roth, you'll pay the income taxes upfront, in the year in which you contribute the money.
But you'll owe no taxes on your contribution or the profits it earns when you take the money out after retiring.
If you can take the hit to your current income, this may be your best bet for building a rich retirement.
Top 9 Benefits Of A 403(b) Plan
Your employer might make matching contributions to your 403(b). Some employers kick in as much as 50 cents to $1 for every dollar you contribute. Others contribute nothing.
In any case, a 403(b) plan can also get you a good deal on investments—often better than you could get on your own. Financial institutions have even been known to waive their minimum investment requirements, helping employees invest in low-expense institutional funds.
Many financial advisors caution against borrowing from your 403(b) account because it leaves less money invested for your retirement. Even though you repay it, you've lost time in which your money could have been compounding.
Contribution and Income Limits
You can set aside up to $19,500 in a 403(b) in 2020 and 2021. For those 50 or older, they can make an additional catch-up contribution of $6,500.
Notably, some 403(b) plans allow certain individuals with 15 or more years working at the same company to make additional contributions—up to $3,000, depending on the particular plan. Check with IRS Publication 571 for a closer look at the 15-year rule and how to calculate allowable contributions.
The total combined contribution limit for 403(b) plans between both the employee and employer is $57,000 in 2020 or $63,500, including the $6,500 catch-up contribution for those employees aged 50 and over. In 2021, the total combined contribution limit is $58,000 or $64,500, including catch-up contributions.
For those who want to participate in a 403(b), your income cannot be more than the annual limit set by the IRS. The annual income limit in 2020 is $285,000, and in 2021, it's $290,000.
Sometimes it's even possible to take out a loan from your account, depending on the rules of your particular 403(b) plan. However, keep in mind that you can trigger heavy IRS penalties for early withdrawal and for missing loan payments.