What is an 403(b)?
A 403(b) plan is a 401(k) equivalent plan designated for certain public education employees and other tax-exempt/non-profit organizations. Participants of this retirement plan often include teachers, school administrators, professors, government employees, nurses, doctors, and librarians.
This plan closely relates to the 401(k) plan used in the private sector, allowing participants to save funds for retirement through payroll deductions while also enjoying certain tax benefits. Employers often match a percentage of the employee’s contribution through their employer matching policy.
The 403(b) plan has similar caps on yearly contributions. For 2022, the annual limit on employee contributions was $20,500 per year for workers under age 50; however, those aged 50 and over can make a $6,500 catch-up contribution to their account. Total contributions cannot exceed $61,000 per year. If the catch-up contribution is included, the limit extends to $67,500.
In order to begin making withdrawals on all types of 403(b) accounts, one has to be at least 59 ½ years old or meet other specific criteria listed by the IRS, such as disability requirements. If one were to withdraw funds before that allotted age condition, an additional 10% early-distribution penalty tax might be added on top of the other taxes one may owe (traditional 403(b)).
Unlike a 401(k) plan, however, 403(b) plans often offer a special plan for those with 15 or more years of service with the same employer.
If an employee has 15 or more years of service with the same non-profit or government agency, they may be qualified to make additional catch-up contributions to their plan. Under this provision, an employee can contribute an additional $3,000 a year, up to a lifetime limit of $15,000, to their 403(b) plan. Unlike the usual 403(b) catch-up provision, you are not required to be 50 or older to take part of this advantage as long as you have worked for the same eligible employer for 15 years.
Different types of 403(b)s
With a traditional 403(b), employee contributions are deducted from their gross income, meaning the money comes from payroll before income taxes have been deducted. As a result, employee taxable income is reduced by the total amount of contributions for the year and can be reported to the IRS as a tax deduction for that year. Taxes are not due on the money contributed to the retirement plan or earnings until the employee withdraws the money, usually in retirement. This 403(b) account is very similar to the traditional 401(k) account in the way its tax savings and advantages work.
With a Roth 403(b), contributions are deducted from the employee’s after-tax income. This means that contributions come from the employee’s salary after income taxes have been fully deducted. As a result, there is no reported tax deduction during the year of the contribution. When the money is withdrawn during retirement, no additional taxes are taken on the employee’s contribution or the investment earnings. This 403(b) account is also very similar to a Roth IRA with the way its tax savings work and is more suited for those with lower incomes.
A key difference between a Roth 403(b) account and a Traditional 403(b) account is that not all employers offer the option of a Roth account. If the Roth 403(b) account is offered, the employee can have the option of picking either account or a mix of both, up to annual limits on their tax-deductible contributions. Employees are allowed to split their contributions, putting money into both a traditional 403(b) and some into a Roth 403(b); however, their total contribution to the two types of accounts can’t exceed the limit for one account, which in 2022 is $20,500.
What are the major objectives of the 403(b)?
403(b) accounts are simple and great investment accounts to help achieve your retirement goals. For most people, the desired goal of their investment is to be earning growth over time and to provide their family with an additional income stream during retirement while also minimizing the impact on their taxes. To determine your retirement goals, you can make a list of general, specific, and investment goals you expect to achieve before retirement. This could, in turn, help you and your partner stay on track.
Why is the 403(b) so important?
The latest health reports and data shows that life expectancy is increasing, leaving a greater number of years in retirement as well as increasing health care costs. Coupled with the future of the financial and economic market, these increasing costs may hinder one’s ability to retire without the proper amount needed or the retirement plan itself. In order to plan for longevity in retirement, one needs to actively participate in financial planning, specifically retirement plans, and one needs to accumulate more money than they actually think they need. Many retirement experts project that one needs roughly 80 to 90 percent of their pre-retirement yearly income to sustain their retirement lifestyle each year. For many, this can roughly equate to anywhere from $1 to $2 million, which can be difficult to achieve without the right retirement account or investment strategy. A 403(b) account is an optimal investment account that can help you reach your retirement goals for those in the public sector and non-profit industries. Not only does this account have tax advantages, but it also has employer matching policies which differentiates this plan from other investment plans like IRAs.
What are the advantages of 403(b)?
A 403(b) plan lets you reduce your tax burden while saving for retirement. Not only are the earnings tax-free, but it’s also hassle-free since contributions are automatically subtracted from your paycheck. This means there will be no reason to worry about investing a certain percentage of your savings each month or year, as it will be automatically be done for you. In addition, many employers will match part of their employee’s 403(b) contributions, effectively giving them a free boost to their retirement savings. This essentially adds a secondary free contribution from your employer, something that other investment accounts, like IRAs, for example, do not provide.
Why You Should Consider 403(b)
One should consider a 403(b) for the many premium advantages it has to offer as an investment account. Contributions to a traditional 403(b) are taken directly out of your gross income before federal income taxes are withheld. Due to the fact that your contributions are pre-tax, it may lower your total taxable income, meaning you owe fewer taxes to the government. It may even put you in a lower tax bracket! Your contributions are then tax-deferred until you withdraw them in retirement. Most individuals end up being in a lower tax bracket once they retire as they stop working. On top of that, contributions are taken automatically from your gross income, making the process simple and effortless.
How Arrowroot Family Can Help You with 403(b)?
If a 403(b) account sounds like the right investment account for you, Arrowroot Family Office can help you begin your investment journey. Arrowroot Family Office understands that creating a comprehensive retirement plan is a challenge for many people. As a result, Arrowroot Family Office specializes in helping individuals achieve financial independence so they can enjoy their retirement and fulfill their retirement goals. Arrowroot Family Office uses different retirement plans tailored to different needs and goals depending on each financial situation. Thus, Arrowroot Family Office can help individuals become confident in their retirement and prepare for any unforeseen events. Click the link to learn more and get started today.
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Frequently Asked Questions
A 403(b) is a retirement savings and investing plan that most public sector employers offer. This retirement plan gives employees a tax break on money they contribute. Contributions are automatically withdrawn from employee paychecks and invested in funds of the employee’s choosing. Employees are given a list of available offerings to invest in.
They are not the same. A 403(b) is a type of employer retirement account offered to public sector employees and those working for non-profits, while an IRA is an individual retirement account. 403(b)s can provide employer matching benefits, while IRAs are known for their pre-tax and tax-deferment benefits. Both investment accounts also have different contribution limits.
403(b)s can be a fantastic investment opportunity to save on your yearly taxes. This option is especially great for employers who have a great employer matching policy that can earn employees greater potential earnings.
Typically, 403(b)s see average annual returns of 5 to 8%, on par with the average return of a 401k and also comparatively well to the average annual returns of an IRA, which sees 7% to 10%. However, this number may be higher or lower depending on your investment strategy.
Savings accounts are ideal for short to medium saving goals, perfect for emergency funds or short savings goals. However, savings accounts return low yields. 403(b)s, on the other hand, are better for longer saving goals that are intended for use during retirement.
403(b) is considered to be not as secure as an IRA due to the event of company bankruptcy or an adverse lawsuit. However, a spouse may still be able to receive those funds after those events.
If possible, it is important to maximize both your IRA and your 403(b). Depending on how high your employer matching policy it would make sense to maximize one over the other. If your employer does not have an employer matching policy, then it would be best to just strictly invest with an IRA account to enjoy all of the tax benefits.
Your 403(b) contributions can reduce your tax liability at the end of the year as well as your tax withholding each pay period; however, you don’t actually take a tax deduction on your income tax return for your 403(b) contributions.
You can use your 403(b) account for education expenses; however, that should not be your primary option. 403(b) plans are specifically dedicated to retirement savings. If you were to withdraw funds before the age of 59 ½, you would incur a 10% premature distribution pentalty on the withdrawal. Thus you would lose a substantial amount of money compared to other investment accounts like IRAs, so use this option as a last resort.
Yes, you can roll a 403(b) into an IRA if the 403(b) provider will allow it. The easiest way to roll a 403(b) into an IRA is to request a direct transfer, which moves the money from your 403(b) into your IRA. People often roll over their 403(b) savings into an IRA when they change jobs or retire. However, the majority of 403(b) plans may still allow employees to roll over funds while they are still working. A 403(b) rollover into an IRA often offers the opportunity for more control, more diversified investments, and flexible beneficiary options.
If one were to go over their 403(b) contribution limit, they would have to pay a 10% penalty for early withdrawal, as one must remove the funds. The funds will be counted as income, and those extra contributions will be double-taxed for each year the extra funds stay in the retirement account.