A 403(b) plan is a tax-deferred retirement plan for certain tax-exempt employers, such as non-profit organizations, some hospitals, and public schools. Contributions can grow tax-deferred until withdrawal at which time the money is taxed as ordinary income. This last fact can be considered a disadvantage, but these plans offer some other advantages. First of all, contributions lower your taxable income, you can make larger contributions to the account, earnings can grow tax-deferred, and some plans allow loans.
Employees working for public school and certain tax-exempt organizations are eligible for participating in this plan. The company determines further eligibility based on employee’s salary and status (full-time vs. part-time).
The annual contribution limits for 403(b)s are $12,000 for 2003, $13,000 for 2004, and $14,000 for 2005. However, some participants can contribute an additional ‘catch up’ amount (of up to $3,000 for 2003, $4,000 for 2004, and $5,000 for 2005) if they are age 50 or above and/or if they have at least 15 years of service and a history of low contributions.Employers can opt to match employee contributions, ranging from 25% to 100% of the participant’s contribution amount. The vesting is determined by the employer, although typically it is automatic.
The employer will choose a specific plan provider who offers different investment options, but the employer is not responsible for administrating the plan.
403(b) plans often offer primarily annuities and some mutual funds. The annuities can be either fixed or variable. The former delivers specific returns while the latter delivers returns based on the performance of the mutual fund. As with all annuities, gains are not taxed until the participant starts receiving distributions.
The 403(b) can be rolled over into an IRA if you have left the employer or if you retire, in case of disability or death. If you are changing jobs, make sure you understand the limitations of an IRA since you will not be able to roll the IRA back into a 403(b) plan.
When changing jobs, the following options are available:
- Roll over the balance into the new employer’s 403(b) plan or an IRA. Doing so will prevent any penalty or withholding of tax.
- Full or partial lump sum distribution, however, fees and penalties will be incurred.
- Leave the plan with the employer. If the balance is below $5,000 you might be required to move the money.
One important note, a 403(b) account can be transferred into another employer’s 403(b) program or an IRA, although the pension stays with the company, but it cannot be transferred into a 401(k).
Some companies will allow loans to be taken from the 403(b) plan. Usually, a participant must reach a minimum balance to be eligible for a loan. Payment of these loans plus a fixed-rate interest are taken directly out of the employee’s paycheck. The interest is not tax-deductible.
Withdrawals, also called distributions, are subject to a penalty of 10% in addition to ordinary income taxes when taken before the retirement age of 59 1/2. After the age of 70 1/2, if the participant is not working, he or she must begin to withdraw the money no later than April 1 of the following year.
Distributions are taken annually after the age of 59 1/2 . For pre-tax contributions, investment earnings and contributions are treated as income. For after-tax contributions, investment earnings are treated as income and contributions are treated as nontaxable return of capital.
The participant can choose one of the following options to receive the distributions:
- Lump sum
- Rollover the balance into an IRA or another 403(b) plan
- Installment payment over the participant’s life expectancy
- Installment payments over the joint life expectancies of the participant and his/her beneficiaries
When opening a 403(b) account, the participant can name primary and secondary beneficiaries. These beneficiaries will receive the balance of the account after the participant’s death. If there are no designated beneficiaries, the amount is given to the spouse (if any), the surviving children (if any), or the estate (if there is no spouse or children).