A 403(b) retirement plan is a valuable savings option designed for employees of public schools, nonprofit organizations, and certain religious institutions. Understanding what is a 403(b) and how it works can help individuals in these sectors make informed decisions about their retirement savings. While similar to a 401(k), a 403(b) is specifically tailored for those in education and nonprofit fields, offering tax advantages that can help build long-term financial security.
This plan allows participants to contribute a portion of their salary into a tax-advantaged account, where funds can grow until retirement. Depending on the type of 403(b) plan chosen, contributions may be made on a pre-tax or post-tax – Roth 403(b) – basis, impacting how withdrawals are taxed later in life.
Planning for retirement is an important step toward achieving financial freedom, and our team is here to help. In this guide, we’ll answer the most frequently asked questions about 403(b) plans so you can make confident and informed choices about your financial future.
How Does a 403(b) Work?
A 403(b) plan is a tax-advantaged retirement savings plan designed for employees of public schools, nonprofit organizations, and certain religious institutions. It functions similarly to a 401(k), allowing participants to contribute a portion of their salary into an investment account on a pre-tax or Roth (after-tax) basis. Employees of tax-exempt 501(c)(3) organizations, teachers, school administrators, hospital employees, and clergy members are among those eligible for participation.
The key difference between a 403(b) and a 401(k) is that 403(b) plans are available to employees of nonprofit organizations, while 401(k) plans are typically offered by for-profit companies. Additionally, 403(b) plans may offer unique benefits, such as catch-up contributions for long-term employees and potentially lower administrative costs.
1. Benefits of Contributing to a 403(b) Plan
Contributing to a 403(b) retirement plan offers several advantages. First, participants can benefit from tax advantages, as contributions are made pre-tax, reducing taxable income, or on a Roth (after-tax) basis, allowing for tax-free withdrawals in retirement. Some employers also offer matching contributions, further boosting retirement savings. Additionally, 403(b) plans typically have higher contribution limits compared to some other retirement accounts. For those who have been with their employer for a long time, special catch-up contribution rules allow for additional savings beyond the standard contribution limits.
2. Investment Options
A 403(b) plan provides various investment options, including mutual funds, annuities, and target-date funds. Employees generally choose from a selection of investments offered by their employer’s plan administrator. While annuities were historically common in 403(b) plans, many now offer mutual funds as a more diversified investment choice. Participants should consider their risk tolerance and long-term financial goals when selecting a mix of stocks, bonds, and other asset classes.
3. Withdrawals and Rollovers
Withdrawals from a 403(b) plan are typically penalty-free starting at age 59½, but distributions taken before this age may be subject to a 10% early withdrawal penalty unless an exception applies. Traditional 403(b) withdrawals are taxed as ordinary income, while Roth 403(b) withdrawals are tax-free, provided the account has been open for at least five years and the participant is at least 59½.
Additionally, Required Minimum Distributions (RMDs) begin at age 73 (or 75 for those born in 1960 or later). For individuals looking to consolidate their retirement savings, a 403(b) can be rolled over into a traditional IRA, Roth IRA, or another employer-sponsored plan, depending on their financial goals. However, rolling a traditional 403(b) into a Roth IRA may trigger taxes on pre-tax contributions and earnings, making it essential to consider the tax implications before initiating a rollover.
4. What Happens When Changing Jobs?
If a participant changes jobs, they have several options for managing their 403(b) balance. They can leave the funds in their current plan, roll them over into an IRA or another employer-sponsored retirement plan, or withdraw them—though withdrawals may be subject to taxes and penalties. If rolling the funds over into an IRA or another 403(b), the tax advantages of the account can be preserved. It is also important to review the employer’s vesting schedule, as employer contributions may not be fully vested until a certain period of employment has been met.
5. 403(b) Plan Administration and Fees
Like any retirement plan, a 403(b) comes with various fees that can impact long-term savings. These may include investment management fees (such as expense ratios for mutual funds), administrative costs (recordkeeping and plan management), and annuity fees if applicable. Participants should review their plan’s fee structure carefully to optimize their savings strategy and minimize unnecessary costs. To track their account balance and make adjustments, employees can log into their plan provider’s website or review their quarterly statements.
Can I Borrow Against My 403(b)?
Many 403(b) plans allow participants to take loans or hardship withdrawals under specific conditions. Loans are typically available for up to 50% of the vested account balance, with a maximum limit of $50,000. To avoid penalties, loans must generally be repaid within five years, unless the loan is used for a primary residence. If a participant leaves their job before repaying the loan, the remaining balance may be treated as a taxable distribution and could be subject to a 10% early withdrawal penalty if they are under age 59½.
Hardship withdrawals, on the other hand, are permitted in cases of immediate and heavy financial need, though they are typically subject to income tax and potential penalties if taken before age 59½. Unlike loans, hardship withdrawals cannot be repaid to the plan. While it is possible to withdraw money from a 403(b) while still employed, withdrawals are generally limited to loans, hardship distributions, or those made after reaching retirement age.
Should I Use Pre-Tax or Post Tax 403(b)?
Choosing between pre-tax and Roth 403(b) contributions depends on an individual’s tax situation and retirement goals. Traditional pre-tax contributions lower taxable income now but are taxed as ordinary income when withdrawn in retirement. Roth 403(b) contributions, on the other hand, are made with after-tax dollars, allowing for tax-free withdrawals later. Employer contributions are always pre-tax, meaning they will be subject to taxation upon withdrawal. For individuals rolling over their 403(b) funds, transitioning to a Roth IRA may result in immediate taxation on pre-tax contributions and earnings, whereas rolling into a traditional IRA does not.
Is There a Roth 403(b)?
A Roth 403(b) is similar to a traditional 403(b), but contributions are made with after-tax dollars, meaning withdrawals—including earnings—are tax-free in retirement, provided the account has been open for at least five years and the participant is at least 59½. Investment options within a Roth 403(b) typically include mutual funds, index funds, and annuities, though available options depend on the employer’s plan provider. Non-qualified withdrawals may be subject to income tax on earnings and a 10% early withdrawal penalty. While Roth 403(b) accounts are subject to RMDs starting at age 73 (or 75 for those born in 1960 or later), rolling over the balance into a Roth IRA eliminates this requirement.
Understanding what is a 403(b) and how it works is key to making the most of this powerful retirement savings vehicle. Whether you’re maximizing contributions, selecting the right investment options, or deciding between a Roth and Traditional 403(b), having a well-thought-out strategy can significantly impact your long-term financial security. With the right approach, a 403(b) can help you build a strong foundation for a comfortable and confident retirement.
If you have any questions or would like to explore whether a 403(b) retirement plan is right for you, our team of CERTIFIED FINANCIAL PLANNERTM (CFP®) professionals would be happy to assist. We can show you how our financial planning process can help you stay on track and achieve your financial goals. Please contact us for a complimentary discovery call at 631.218.0077. You can also click here to send us a message directly.
R.W. Rogé & Company, Inc. is an independent, fee-only financial planning and investment management firm serving clients locally and virtually across the country, with Long Island, New York, and Beverly, Massachusetts office locations. R.W. Rogé & Company, Inc. was founded on a “client first” culture and proudly commits to acting in your best interest as a fiduciary. We have helped clients Plan, Achieve, and Live® the life they want since 1986. To learn more about how we do this, explore our detailed overview of services and approach.
