A 403(b) plan is a type of tax-sheltered retirement plan for the employees of nonprofit entities, such as schools, charities, and religious organizations. It has much in common with the more widely recognized 401(k) plan, but with some key differences.
If you are eligible to participate in a 403(b) plan at work, you'll find it has numerous benefits. Let's take a look at nine of them.
- 403(b) retirement plans for employees of schools and nonprofit organizations work much like 401(k) plans in the for-profit sector.
- If your employer offers it as an option, you may be able to invest in a Roth account, where you'll get no upfront tax break but your withdrawals in retirement will be tax-free.
- A feature unique to 403(b) plans allows some employees with 15 years of service at the same employer to make extra contributions.
1. Tax-Deductible Contributions
Contributions to a traditional 403(b) plan are deductible for federal income tax purposes. In effect, the money comes out of your salary and goes into the 403(b) plan without your having to pay any taxes on it. The tax deduction is valuable because it reduces the amount of income tax an individual owes, based on their top marginal tax rate. For example, if the last $10,000 of your adjusted gross income is taxed in the 22% tax bracket, putting $10,000 into a traditional 403(b) would mean a tax savings of $2,200.
In addition, "earnings apply to the entire balance, not one reduced by taxes. This increases overall returns," says Elyse Foster, CFP®, founder of Harbor Financial Group, in Boulder Colo.
2. Taxes Waived Until Retirement
If you make pretax contributions to a traditional 403(b) plan, you won't have to pay taxes on that money, or its investment earnings over the years, until you take distributions in retirement. The good news is that most people are in a lower tax bracket after they retire.
3. Possible 403(b) Roth Option
Since 2006, employers have had the option to allow Roth contributions to 403(b) plans. Unlike a traditional 403(b), contributions to a Roth 403(b) are not eligible for a tax deduction. However, when you make withdrawals from the Roth portion of your plan, those withdrawals are not taxable. Not all 403(b) plans have a Roth option, but if yours does, it's worth considering.
Top 9 Benefits Of A 403(b) Plan
4. Tax-Free Growth
A huge advantage of a 403(b) plan, as with a 401(k), is that you don't have to pay taxes on the dividends, interest, or capital gains your investments earn until you eventually take out that money. (With a Roth 403(b) account, you won't even be taxed then.) By contrast, if you hold your retirement investments in taxable accounts, you'll be taxed on their earnings every year.
Since you don't have to worry about tax effects in your 403(b), you can rebalance your portfolio more often without losing anything except possible trading fees. You also don't have to worry about the tax efficiency of any mutual funds you hold, so you can focus on funds with high returns and low expenses.
5. Loan Provisions
Depending on the rules of your particular 403(b) plan, you may be entitled to take a loan from your account. This can be helpful in certain situations, such as buying a home. However, many financial advisors caution against borrowing because it leaves less money in the 403(b) plan invested for your retirement. The rules on 403(b) plan loans can also be very exacting. Missing even one payment could mean that you have defaulted on the entire loan amount, triggering IRS penalties for early withdrawal.
You may be able to take a loan from your 403(b) account, but financial advisors warn that it isn't always a good idea.
6. Matching Contributions
Another good reason to put money into a 403(b) is if your employer makes matching contributions. For example, your employer might kick in another 50 cents or $1 for every dollar you contribute, up to certain limits. This is essentially free money.
7. Access to Low-Cost Funds
Because a 403(b) plan may control many millions of dollars in assets, it can often get you a better deal on your investments than you could get on your own. To entice big clients like retirement plans, financial institutions sometimes waive their high minimum investment requirements so that employees can invest in "institutional" funds with extremely low expenses. For example, the Vanguard Institutional Index Fund Institutional Plus Shares (VIIIX) has an expense ratio of just 0.02% and normally requires an investment minimum of $100 million. However, individuals can invest in this fund through a 403(b) if their employer offers it.
"Essentially the fund company provides a large discount in regards to the expense ratio (the cost to invest in the fund) for companies that have large retirement plans. This could save you upwards of half a percent per year in costs, which is all more money in your pocket," says financial planner Kevin Michels, CFP®, with Medicus Wealth Planning in Draper, Utah.
8. Higher Contribution Limits
A 403(b) plan also allows you to set aside more money each year than some other types of retirement accounts. As an employee, you can put up to $19,000 into a 403(b) in 2019. If you're 50 or older, you may be eligible to make an additional catch-up contribution of up to $6,000, for a total of $25,000. By contrast, the limit on IRAs in 2019 is $6,000, plus a $1,000 catch-up contribution, for a maximum of $7,000.
9. Additional Contributions
A unique benefit of 403(b) plans is that they allow some people who have 15 years of service with the same employer to make additional contributions of up to $3,000, if their plan permits it. The IRS explains the 15-year rule and how to calculate your allowable contribution in Publication 571.
"I have had teachers who have taken advantage of the 15-year rule with their employers. They saved a little extra on top of the large amount they were already putting away in the last few years of 'power' savings right up until retirement," says Martin A. Federici, Jr., AAMS®, MF Advisers, Inc., in Dallas, Pa. "There are caveats to this, of course, but the benefit for a pre-retiree can be huge, especially if they haven’t saved enough in the past."
This also means that if you were young when you started with your employer, you won't have to wait to age 50 to start increasing your retirement contributions, if you can afford to do so.
The Bottom Line
As you can see, there are many things to like about 403(b) plans. Still another plus comes from making regular, automatic contributions. "One of the great features of a workplace retirement plan like a 403(b) is the way it invests a set dollar amount determined by the employee, regardless of whether the market is up or down. This process is called dollar cost averaging and it helps investors who may otherwise be emotional about steep drops in the market stay on track," says Stephanie Genkin, CFP®, founder of My Financial Planner, LLC, in Brooklyn, N.Y.