403(b) Retirement Savings Scheme: Functionality and Advantages and Disadvantages

403(b) Retirement Savings Scheme: Functionality and Advantages and Disadvantages

Unless you're a non-educator or non-employee of a tax-exempt organization under section 501(c)(3), you might not be acquainted with the 403(b). Named after the IRS section that determines it, a 403(b) is a particular type of retirement savings plan, similar to a 401(k), but with some distinct features.

Here's a concise rundown of 403(b) retirement plans, featuring their advantages, disadvantages, and contribution limits, to help you optimize the most out of this account.

What is a 403(b) plan?

A 403(b) plan is a kind of retirement fund accessible to individuals who work in public education and certain 501(c)(3) tax-exempt organizations. It's akin to the more well-known 401(k) account, which is usually provided by private sector employers. A 403(b) is frequently utilized by government workers, medical professionals, librarians, self-employed ministers, and employees of public schools, including teachers and administrators.

Just like a 401(k), a 403(b) account lets you defer a share of each paycheck for retirement purposes, and your employer may contribute some of your wages if they choose to do so. A 403(b) can be either tax-deferred, which means your contributions decrease your taxable income for that year, and you pay taxes on distributions during retirement, or a Roth 403(b), which implies you pay taxes on your contributions this year, and your money increases tax-free from that point onward.

Pros and cons of a 403(b)

Let's take a more in-depth look at some of the advantages and disadvantages of a 403(b) plan:

Tax advantages

| Advantages | Disadvantages || --- | --- || Tax advantages | Limited investment options || High contribution limits | Higher fees || Employer matching | Early withdrawal penalties || Faster vesting schedules | Not always covered by ERISA || Extra catch-up contributions |

Few investment choices

Benefits of a 403(b) plan

On the bright side, contributing to a 403(b) account brings the following advantages:

High contribution limits

• Tax advantages: Generally, 403(b) accounts share the same tax advantages as 401(k)s and IRAs. Depending on whether you select a traditional or a Roth 403(b), you can enjoy a smaller tax bill this year in exchange for taxes on distributions during retirement or tax-free withdrawals during retirement if you pay taxes on your contributions.
• High contribution limits: Contribution limits for 403(b) accounts, as described below, are on par with 401(k) contribution limits and significantly higher than IRA contribution limits.
• Employer matching: Employers offering 403(b) plans may offer to match certain employee contributions, just like companies offering a 401(k) might do. Each employer sets its own rules regarding how, when, and if it will match employee contributions. Check with your HR department for specific information about your company's matching program.
• Shorter vesting schedules: Vesting schedules determine when your employer-matched funds become fully yours. This varies from company to company, but 403(b) vesting schedules are typically shorter than 401(k) vesting schedules. Some 403(b)s may offer immediate vesting, meaning you keep all employer-matched funds that have been contributed, regardless of when you leave that job.
• Extra catch-up contributions: In addition to the standard catch-up contributions for adults aged 50 and older and the increased catch-up contribution for adults aged 60 to 63 starting in 2025, 403(b)s enable participants who have served at the same employer for at least 15 years to contribute up to $3,000 in extra funds per year to their accounts.

High fees

Drawbacks of a 403(b) plan

It's important to recognize some of the downsides to contributing to a 403(b) account:

Employer matching

• Limited investment options: Until recently, 403(b)s only provided variable annuities as investment options. While this is no longer the case, this type of account offers fewer investment choices than a 401(k) or an IRA.
• Higher fees: Some 403(b)s charge higher fees, which can reduce your returns, although this isn't true of all 403(b)s. To avoid this, research the plan's administrative costs and any investment-related fees, and try to keep them as low as possible to maximize your returns.
• Early withdrawal penalties: If you withdraw funds from your tax-deferred 403(b) before age 59.5, you'll pay a 10% early withdrawal penalty, in addition to taxes. However, this penalty can be waived if you have a qualifying reason, such as a substantial medical expense. Note that this applies to IRAs and 401(k)s as well.
• Not always subject to ERISA: The Employee Retirement Income Security Act (ERISA) establishes minimum standards for retirement plans, including reporting and fiduciary standards, to protect employees. But many 403(b)s are not subject to ERISA. While this doesn't mean they're poor plans, it's important to conduct additional research to decide if it's the right home for your money before beginning contributions.

Penalties on early withdrawals

Related Retirement Topics

The Fundamentals of Roth 403(b) Plans

Shorter vesting schedules

Learn about this type of retirement plan that may be suitable for those working in nonprofits.

Not always subject to ERISA

What is a 401(k) and How Do They Work?

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Extra catch-up contributions

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You can deposit up to $23,000 into a 403(b) in 2024, or $23,500 in 2025. If you're 50 or older, these limits increase to $30,500 (2024) and $31,000 (2025). Individuals between 60 and 63 can contribute up to $34,750 in 2025. These limits mirror the contribution limits for a 401(k). It's worth noting that if your employer offers both a 401(k) and a 403(b) in the same year, the limit applies to your overall contributions to both accounts.

There's a possibility you could contribute an extra $3,000 past standard contribution limits in a given year if you've been with your employer for at least 15 years. However, there's a $15,000 lifetime maximum on this, so if you fall into this category, you'll want to pay close attention to the extra contributions you make.

Of course, you're not obligated to contribute this much annually if it's not feasible for you. You can set your own savings rate and adjust it as often as necessary. Typically, you decide what percentage of each paycheck you want to put towards retirement, and if your company matches some of your contributions, the matching contribution will also be based on a percentage of your annual income.

A 403(b) can be a beneficial retirement savings tool. Just remember to stay informed about the rules and fees to help your retirement savings grow as rapidly as possible and avoid unnecessary penalties.

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After learning about the various features and considerations of a 403(b) retirement plan, it's crucial to strategize how to make the most of this opportunity. One way to maximize your 403(b) savings is by understanding the contribution limits. For instance, in 2024, you can contribute up to $23,000, or $23,500 in 2025, into your 403(b), with an additional allowance of $30,500 or $31,000, respectively, if you're 50 or older.

Considering the potential for retirement savings, managing your finances becomes especially important during this stage of life. By making informed decisions about your retirement plan and optimizing your contributions, you can ensure your money is working for you and prepare for a comfortable financial future. This is a time to focus on retirement finance and 403(b) money management to reap the most benefits as you approach retirement.

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