A 403(b) is a tax-deferred retirement savings plan for employees of educational institutions and nonprofit organizations. These plans are employer-sponsored and allow participants to contribute pretax dollars. Similar to private sector 401(k) plans, 403(b) plans have various rules and regulations regarding contribution limits, withdrawals and other factors.
403(b) plans are available to most employees of educational institutions, such as schools, colleges and some nonprofit organizations. Some plan participants include: teachers, professors, school administrators, doctors, nurses and others.
Funding 403(b)s
Contributions to 403(b) plans can be funded by pre-tax employee contributions, after-tax contributions, and employer contributions. Income tax is not accessed until retirement. For 2010, participants can contribute up to $16,500. Participants 50 and older can contribute an additional $5,500. In 2009, the contribution limits go up to $16,500 or $22,000 if you are over 50 years old.
There are two types of 403(b)s:
- Traditional 403(b) plans allow pre-tax contributions so that taxes can be deferred on the portion of the salary that is contributed into the plan. Plans offer employer matching contributions. After retirement, earnings and original contributions are taxed.
- Roth 403(b) plans are funded with after-tax dollars. Thus there is no initial tax benefit. However, as the fund grows, you pay no taxes on qualified distributions. While investment options vary, the most common choices include annuities and mutual funds.
With both investment options, penalty-free withdrawals from 403(b)s cannot occur until after the age of 59 1/2. If withdrawn prior to that, a 10 percent penalty tax is applied to most withdrawals in addition to normal income taxes. After retirement age, withdrawals are taxed as ordinary income. Most plans require that distributions no later than April 1 of the following year when a participant turns 70 ½.
403(b) vs. 401(k)
There are many similarities between 403(b) and 401(k) plans. However, there are some key differences as well. For example, with 403(b)s employers need only establish the elective payroll deductions. After that, they have virtually no involvement with the plan. This means that if you leave your job, you can keep your money in the plan as long as you like. This option is not available with all 401(k)s. Another key difference is that vesting is immediate with 403(b)s, while 401(k)s can take up to 6 years before you become fully vested.