403(b) plans were established to serve employees of educational institutions, religious organizations, and tax-exempt entities. Eligible individuals have the opportunity to set up and maintain their own 403(b) accounts. Their employers have the option to contribute to these accounts and frequently do so. Participants can choose from three distinct types of 403(b) plans. The first option is an annuity plan provided by an insurance company. These plans are often referred to as TDAs (tax-deferred annuities) or TSAs (tax-sheltered annuities). The second type is an account offered and administered by a retirement custodian. In these 403(b) accounts, participants are limited to selecting from a range of mutual funds and regulated investment companies approved by the custodian. The third variety is a retirement income account, which allows for a combination of mutual funds and annuities as investment options.
Employers retain some level of control over these accounts. They have the authority to select the financial institution that will hold their employees’ 403(b) accounts. This decision determines the specific type of plan that employees can establish and fund. Offering a 403(b) plan provides several advantages for employers. The benefits they can extend to their workforce are valuable, helping to retain key employees. Additionally, employers appreciate the ability to share funding costs with their employees. They also have the option to structure the 403(b) to accept only employee contributions if they prefer not to participate financially in the account.
Employees derive numerous benefits from these retirement vehicles. They can make tax-deferred contributions from their income, as well as contribute after-tax dollars to the accounts. In Roth 403(b) accounts, all earnings grow tax-free for the entire duration of the account. By deferring tax payments until retirement, employees often find themselves in a more favorable tax bracket, potentially resulting in lower overall tax liability. Furthermore, employees have the option to take loans from their 403(b) accounts when needed.
A wide range of non-profit organizations can establish 403(b) plans for their employees. This includes any 501(c)(3) tax-exempt organization, cooperative hospital service organizations, public school systems, ministers of churches, Native American public school systems, and the Uniformed Services University of the Health Sciences (USUHS).
403(b) plans can accommodate various types of contributions. Employees may opt for elective deferral contributions, which are deducted from each paycheck on a pre-tax basis. They also have the option to contribute after-tax dollars, which are similarly deducted from their payroll. Employers can choose to make either discretionary or fixed contributions as they see fit. Both employees and employers can contribute to Roth 403(b) accounts. These 403(b) plans can accept any combination of the aforementioned contribution types, showcasing their flexibility.
Employees benefit from generous annual contribution limits with these plans. As of 2016, they could contribute up to $18,000 (or $24,000 for those over 50 years old who are catching up on retirement contributions). In the same year, employers could deposit up to $53,000 (not exceeding 100% of the employee’s compensation) as an annual contribution.
Regarding distributions, the rules for 403(b) plans are similar to those of other retirement savings vehicles. Distributions of tax-deferred dollars become taxable as regular income when the employee receives them. If these withdrawals occur before the employee reaches age 59 ½, the distributed amount is subject to a standard 10% penalty for early withdrawals. However, there are exceptions to this penalty for which an employee may qualify. One such exception applies if the employee terminates their job prior to reaching retirement age.
