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What is a '403(b) Plan'

A 403(b) plan is a retirement plan for specific employees of public schools, tax-exempt organizations and certain ministers. These plans can invest in either annuities or mutual funds. A 403(b) plan is also another name for a tax-sheltered annuity plan, and the features of a 403(b) plan are comparable to those found in a 401(k) plan.

BREAKING DOWN '403(b) Plan'

Employees may make salary deferral contributions, but they are bound by regulatory limits. Individual accounts in a 403(b) plan include an annuity contract, bought through an insurance company or a custodial account, which invests in mutual funds or a retirement income account established for church workers.

Employees of tax-exempt organizations are eligible to participate in the plan. Participants include teachers, school administrators, professors, government employees, nurses, doctors and librarians. A TSA is another funding source for retirement in addition to a retirement plan or pension that helps employees meet their retirement goals. Many plans vest funds over a shorter period than 401(k) plans or may allow immediate vesting of funds.

Benefits of a 403(b) Retirement Plan

Earnings and returns on amounts in a 403(b) plan are tax-deferred until withdrawn. Earnings and returns on amounts in a Roth 403(b) are tax-deferred if the withdrawals are qualified distributions. Employees age 50 or over can make catch-up contributions to both plan types, and employees may be eligible for matching contributions, which varies by employer.

For example, an employer matches funds at 50 percent of any employee contribution up to 6 percent of his or her salary. If an employee earns $75,000 and contributes 6 percent per year, the employer contributes $2,250 per year, which is essentially free money toward the employee's retirement. This helps employees exceed the annual maximum contribution limits, receive tax deductions and accelerate their retirement goals.

How to Contribute to a 403(b) Plan

Different types of contributions fund TSAs, such as after-tax contributions, nonelective contributions and elective deferrals. After-tax contributions are voluntary contributions that a participant must include as income when filing taxes. Nonelective contributions are mandatory employer contributions, such as discretionary contributions that include end-of-plan-year contributions or profit-sharing contributions. Elective deferrals are voluntary contributions set up by the employee that allows an employer to withhold money from the employee's paycheck to be paid directly into his or her TSA. These contributions are a percentage of the employee's salary. Another funding option is using a combination of elective, nonelective and after-tax contributions. 

All employee contributions are limited to $18,500 per year, as of 2018. The combination of employee and employer contributions are limited to the lesser of $55,000 per year, as of 2018, or 100 percent of the employee's most recent yearly salary.

Disadvantages of a 403(b) Plan

A 403(b) plan withdrawal before age 59 1/2 is subject to a 10 percent tax penalty. A participant may avoid the penalty under certain circumstances, such as separating from an employer when a person reaches age 55, a qualified medical expense, death of the employee or disability. Withdrawals are subject to 20 percent federal income tax withholding unless the total amount is transferred to another qualified retirement plan or individual retirement account. However, if a participant wants to dissolve an annuity investment, the participant must pay a surrender charge of up to 8 percent of the investment.

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