Many people know they should contribute to a 401(k) account to secure an enjoyable, comfortable retirement. But if you work for a nonprofit, a state agency, or a university, your employer might offer you a 403(b) instead.
A 403(b) is very similar to a 401(k). Both retirement accounts are tax-deferred, which means that you don’t have to pay taxes on the money that you deposit, though you do have to pay taxes on the money when you withdraw it. Depending on how your employer sets up the accounts, you may also be able to contribute simultaneously to a Roth 403(b), which allows you to contribute on an after-tax basis and avoid paying taxes on withdrawals.
What differentiates a 403(b) from a 401(k) is that only employees of nonprofits, schools, and other tax-exempt organizations can have one. It’s also generally less difficult and expensive to administer a 403(b), which is why nonprofits are permitted to use them.
Common Questions Regarding 403(b) Retirement Plans
How Much Can I Contribute?
In 2012, you can contribute up to $17,000 to your 403(b), and if you’re over the age of 50, you can contribute an extra $5,000 for a total of $22,000. In most circumstances, you must contribute to your 403(b) by payroll deduction out of your paycheck.
As an added bonus, if you have 15 years of service or more with your current employer and contributed an average of $5,000 or less per year, you can contribute an additional $3,000 during the year. This additional catch-up amount is limited to $15,000 total over the years after you start catching up.
What Can My 403(b) Contributions Be Invested In?
Your workplace probably has a contract with a specific financial services firm, such as TIAA-CREF or Fidelity, to administer your 403(b). Your investment options vary depending on what is available at each firm, but generally, you have a variety of mutual funds and annuity products to choose from. However, you cannot invest directly in stocks or bonds using a 403(b).
When Can I Withdraw My Contributions?
Typically, you must wait until you’re 59 1/2 to withdraw contributions without penalty if you’re still working. However, if you retire at age 55 or older, you may be able to make withdrawals penalty-free. Otherwise, the penalty is equal to 10% of the amount withdrawn early, and you pay it when you file your taxes the next year.
After you are old enough to be eligible, you can withdraw as much as you want, but you must withdraw at least a minimum amount each year after you turn 70 1/2. The minimum withdrawal amount is based on the total account balance and your age, and if you don’t withdraw it, you could be subject to heavy IRS penalties.
Can I Borrow Against a 403(b)?
Yes, depending on the rules of the particular financial services firm that holds your account. The IRS requires loans to be limited to the smaller of $50,000 or half the account’s value, but the servicer may have limits that are lower than that. Not all financial services firms allow loans, and the interest rates are set by the firm based on current interest rates.
Loans must be repaid within five years, and there can be serious tax consequences if you default on the loan. Your financial services firm treats it as an early withdrawal, meaning that the amount is subject to income taxes and the 10% early distribution penalty.
How Much in Taxes Will I Owe on My Withdrawals?
If you withdraw money after you retire, you will owe ordinary income tax on the money. Withdrawals are taxed as ordinary income, so how much you owe depends on what other income you had for the year. Adding that withdrawal to your other income can mean the withdrawal is taxed at a higher tax bracket than the rest of your income.
If you withdraw early, you will owe both the income tax on the withdrawal, plus an extra 10% penalty amount. And if you’re withdrawing quite a bit, you may want to pay estimated taxes ahead of time to avoid getting hit with an underpayment penalty.
Additionally, you will owe separate penalties if you don’t withdraw your minimum required amount if you’re over the age of 70 1/2.
What Happens to My 403(b) If I Get a New Job?
Just like a 401(k), you can transfer your 403(b) to a traditional IRA when you leave your job. You can also choose to leave it where it is, although you may be forced to move it if the balance is less than $5,000.
If your new employer also offers a 403(b), you can simply transfer the money from your old 403(b) directly to the new one.
What Is a Hardship Withdrawal?
In certain serious circumstances, most financial services firms permit you to make a hardship withdrawal. This is an early withdrawal made while you’re still working – not a loan. For example, if you need to use some of the money in your 403(b) for an emergency and have no other assets available to you, such an exception could be made. However, you would still owe regular income taxes and a 10% early withdrawal penalty on the money no matter what.
These situations include:
- Large unreimbursed medical expenses for yourself, your spouse, or dependents
- A down payment on a primary residence
- Higher education tuition or fees that are due in the next 12 months
- Eviction or foreclosure on your home
However, the servicing firm is not required to allow these distributions even if you meet the criteria, and they may require certification that you don’t have any other assets and that the hardship is real.
Can I Also Use an IRA?
You can contribute to an IRA in addition to contributing to a 403(b). There are no restrictions on having both types of accounts and contributing to both in the same year.
To maximize savings in your 403(b), invest in mutual funds that match your risk tolerance and personal situation. For example, if you are a young and aggressive investor, a small-cap growth fund could be ideal for your portfolio.
On the other hand, if you’re nearing retirement, you may want to play it safer by allocating a portion of your savings to bonds via a bond mutual fund or by investing in a fixed annuity. But bottom line, don’t let the details intimidate you. Up your contributions, if possible, or start saving if you haven’t yet. Either way, you’ll appreciate the extra effort when you retire.
What is your experience with a 403(b) account?