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Another Tax-Sheltered Employee Retirement Plan: The 403(b)

For those who work in a non-profit organization, like a school, social service agency, college, hospital system or a museum, the 403(b) plan is the retirement plan offered by non-profit employers. This is a smart way to save for retirement, deferring taxable income to a time when incomes are lower, and, therefore, income tax rates for distributions are lower.

Investopedia’s article, “The Top 9 Benefits of a 403(b) Plan” examines the top nine benefits of a 403(b) plan.

Your contributions are tax deductible. Contributions are placed into the 403(b) plan without requiring you to pay any taxes on it. The tax deduction can be a benefit because it reduces the amount of income tax paid at the individual’s marginal tax bracket.

Taxes are paid on distributions in retirement. If you make traditional pretax contributions, you’ll need to pay taxes on distributions in retirement. However, most people are in a lower tax bracket when they retire and need less income than at their peak earning years.

Some 403(b) plans have a Roth option. Beginning in 2006, employers have had the choice to allow Roth contributions to 403(b) plans. Roth contributions aren’t eligible for a tax deduction. When you make withdrawals from the Roth portion of your plan, those withdrawals aren’t taxable.

Your savings grow tax-free. A major advantage of a 403(b) plan is that you don’t have to pay taxes on dividends, interest, and capital gains on investments held in the 403(b) account.
You can take out a loan on a 403(b). While it depends on the specifics of your 403(b) plan, most allow you to take a loan. Note that the requirements for the loans are very strict, and if you miss even one payment, it can mean defaulting on the entire loan amount. This triggers IRS penalties for an early withdrawal.

Your employer may offer matching contributions. If your employer offers matching contributions, make certain to contribute to take advantage of this free money. Employers can only contribute to a 403(b) on a pretax basis, and they’ll match Roth contributions up to specified limits—but they must do so with pretax money. Therefore, 403(b) contributions matched by an employer are subject to taxation of the initial amount and any subsequent capital gains.

You may be able to invest in low-cost “institutional” funds. In some instances, 403(b) plans can get a better return on investments, than individuals can get on their own. That is because while financial institutions will often reject undertaking small portfolio responsibilities, taking on 403(b) fund management role means they have access to hundreds of millions of dollars of new assets. To entice big clients, institutions will occasionally waive the prohibitively high minimum investment requirements, so employees can invest in “institutional” funds, which have extremely low expenses. In effect, the fund company provides a big discount on the expense ratio (or the cost to invest in the fund) for companies that have large retirement plans, which could save up to of half a percent per year in costs. That’s more money in your pocket.

The contribution limits are higher than for IRAs. An employee can put up to $18,000 into a 403(b), and employees who are 50 or older may be eligible to make up to a $6,000 additional catch-up contribution. These contribution limits are enormous, when compared with the $5,500 limit and $1,000 catch up limits on IRAs.

Additional contributions may be permitted by the “15-Year Rule.” A unique benefit of 403(b) plans is that they permit more contributions for people who have 15 years of service with the same employer and haven’t contributed in excess of the cutoff point in previous years.

Just like any other retirement plan, the best strategy with a 403(b) is to start saving as early in your career as possible and being consistent in adding funds to the account. Over a lifetime of work, even small contributions, made frequently, can grow into a sizable retirement fund.

Reference: Investopedia (October 15, 2018) “The Top 9 Benefits of a 403(b) Plan”

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