It is vital to save for retirement, but how do you choose which type of account to use? 403(b) plans are great because they have tax advantages and provide a source of income in retirement. In this post, we will discuss the plan in-depth and how it can help increase your wealth over time.
What is a 403(b) Plan?
This plan is a tax-advantaged way to save for retirement. Named after Section 403 of the Internal Revenue Code, this type of account can be opened by certain public school employees, as well as some church ministers and nonprofit organizations, in addition to many other professionals.
This plan is a retirement investment account for employees in which they can defer money from their paycheck. These plans are like 401(k)s. In both types of plans, people need a company that is their plan provider and a person who is their plan administrator. The investment options for each plan are limited to what the specific type of plan offers.
These accounts used to be called “Tax Sheltered Annuities.” They were set up to only offer annuities as an investment choice but changed later. Although more types of investments are now eligible to be offered, many plan providers for these still mainly offer annuities. Annuities often dominate 401(k) plans as well.
Many employers who offer these plans do not offer contribution match programs. This is because they would need to follow ERISA regulations and guidelines. That said, a 403(b) avoidance of ERISA guidelines often means lower administrative costs and fees.
Understanding 403(b) Plan
The plan is in many ways identical to its better-known cousin, the 401(k). They both offer employees a tax-advantaged way to save for retirement. Investment choices are often more limited with this plan, but it’s worth noting that these plans only serve public and nonprofit sector jobs.
The features and advantages in this plan essentially mirror those found with 401 (K). Both share the same contribution limits: $19,500 per year from 2020 through 2021. There is a limit on how much fund you can put into your retirement account. The limit depends on your salary and the year. In 2021, it won’t be more than $58,000, and in 2020, it’s not more than $57,000.
Both plans also offer Roth options and require participants to be age 59½ before they can take withdrawals without acquiring an early withdrawal penalty. If you are 50 or older, the plan offers a $6,500 catch-up contribution in 2020 and 2021.
This is different from a 401(k) because it also has extra benefits for people who work with the same employer for 15 or more years.
Although it is less common, you could potentially be eligible for both this plan and 401(k) plans.
If you work for a company that has both a 401(k) and 403(b), you can put money into both. But the amount you can put in is limited to $19,500, not counting any catch-up contributions.
Advantages of 403(b) Plan
Returns and earnings on your money for a regular 403(b) plan are tax-deferred until you withdraw it. Total earnings and returns in a Roth 403(b) are not taxed if the withdrawals are qualified distributions.
Employees who have this plan may be able to receive matching contributions from their employers, the amount of which varies depending on the company. It is possible that these plans could lead to lower administrative costs in contrast with those without employer matches but deprive employees of what would essentially be free money.
There are plans that are not required to meet the strict rules of the Employee Retirement Income Security Act. They have lower administrative fees than 401(k)s or other retirement plans with more regulations. One of these rules is that there can’t be employer contributions.
Many of these plans vest fund over a shorter period than 401(k)s, and some even allow immediately vested of money. If you have 15 or more years of employment with certain nonprofits or government agencies, you can make additional catch-up contributions to this plan. This is not something that people who have a 401(k) plan can do.
The new law lets you contribute up to $3,000 more every year. That’s for a total of $15,000 in your lifetime. And unlike the catch-up provisions on other types of retirement plans, you don’t have to hold off until you turn 50 to take advantage of it. You just need 15 years with the same eligible employer.
Disadvantages of 403(b) Plan
The first thing to know about this kind of plan is that withdrawals before age 59½ are subject to a 10% tax penalty. You can avoid this by separating from an employer at 55 or older, needing to pay for qualified medical expenses, and becoming disabled in the process.
This may offer a more limited selection of investment options than other types of retirement plans. This is because mutual fund companies typically administrated 401 (k) ‘s, which can provide diverse and versatile investment options to its participants.
The type of investments you can make under this will depend on the provider. Some providers offer mutual fund choices, but many only have variable annuities contracts for investment options. That being said, both fixed and variable annuity contracts are permitted with some limitations—mutual funds are your sole option if choosing from this kind of company inside these plans. Other securities such as stocks and REITs cannot be purchased in any capacity within one of these accounts.
At best, an investment option that this plan favors can be a mixed blessing. In 1958, the plan was created to be a retirement account with tax-sheltered annuities. Nowadays, many still provide this type of investment and can offer mutual funds as well.
These investments can provide some advantages, but financial advisors often recommend against investing in annuities for a lot of reasons.
For these plans that do not have ERISA protection, accounts may lack the same level of protection as 401(k) ‘s, which are required to comply with ERISA. If you are at risk of creditors go after your assets, speak to a local attorney who understands the nuances of state law. The laws may be complex and vary from one state to another.
Non-ERISA 403(b)s are exempt from nondiscrimination testing done annually, designed to prevent management level or highly compensated employees from receiving disproportionate benefits.
Plan Rollover Rules & Limitations
If you have a thee type of plan, you can move it without any taxes to another account like an IRA, 401(k) account, or other qualified plans. Here are an outline of some 403(b) rollover regulations:
- When you go to withdraw or rollover funds from your plan, be aware that the IRS will deem it as a taxable event if you don’t do this within 60 days. To make matters worse, if you are not yet 59 ½ years old, the IRS will also impose a 10% penalty on future withdrawals.
- You are constricted to one rollover per year from your plan into an IRA. This one-year period starts on the date that you receive your distribution, and this applies separately for each of the IRAs that you own.
- You cannot use the money from your distribution to buy investments in the time period between when you get your plan distribution and when you establish a new IRA.
It is recommended that you choose the option to carry out a “direct rollover” with your funds. In a direct rollover, you don’t receive a check from your distribution. Rather, your plan provider will transfer the money directly into your new IRA plan.
403(b) vs. 401(k): How They Compare
The 403(b) is like a cousin to the 401(k). The two plans are similar. There is not much difference in the limit for how much you can put in each year, and there are special rules about when you can withdraw money. The two plans are similar in that they both allow pre-tax and post-tax Roth contribution options as well employer contributions. But there are a few differences:
Types of Employers
The 401(k) plan is for the benefit of private-sector employers, but the 403(b) plan is designed to benefit nonprofit and government organizations.
ERISA is a law that provides protection for employees and their retirement savings. Unlike employers who offer 401(k)s, those offering 403(b) ‘s are not required to follow certain ERISA rules.
However, some plans may not abide by the non-discrimination requirements and offer preferential treatment to employees. One notable exemption on ERISA is that employers cannot make employer contributions under a 403(b) plan.
The 403(b) plan enables you to save up for the future with $3,000 in bonus catches per year. If you work at the same company for 15 years or more, that’s a total of $15,000.
Insurance companies often administer 403(b)s, which means they offer annuities as retirement investments. 401k plans are generally administered by big financial firms and provide a wide range of investment opportunities depending on age or whether you’re retiring soon.
Shorter Vesting Periods
Employer contributions to retirement accounts often come with a vesting period. This means that employer contributions aren’t immediately the employee’s, and if they leave an employer before a fixed amount of time, they may relinquish some or all of their accrued employer contributions. 403(b) plans either do not have vesting periods or have very short vesting periods.
How to Invest in a 403(b)
The investment options in these plans are more limited than other tax-advantaged retirement accounts. You can choose from two kinds of things: a mutual fund or an annuity. You cannot invest in individual stocks, ETFs, or REITs with these accounts.
Many 403(b)s will give you low-cost funds for investing in your retirement. These are the funds that experts recommend. Despite how much time you have before retirement, determining the appropriate ratio between stock funds and bond funds involves balancing risk with your willingness to take on risk. This usually means you should put your money in stocks when you’re young. As you get older, you should put your money in bonds.
When you’re contemplating retirement, it can be a bit daunting to think about how much savings is needed. But not if your plan offers target-date funds! Target date fund automatically adjusts their holdings so that near the time of retirement, they’ll have less risk and more stability than when you first started investing in them.
With the right guidance, annuities can be a great option for retirement. Ask your financial advisor about what types of annuities are available to you and how they work before deciding if this is an investment worth considering.
If you don’t like the choices in your plan, you can also use an IRA to make your portfolio better. If your employer matches contributions to this plan, make sure you contribute enough before investing in an IRA.
Kinds of Gold You Can Invest in Through a 403(b) Plan
The plans offer more investment options than they used to. They often have the fewest retirement plan choices of any plan.
Though not available to everyone, the plans may include a few options:
- individual stocks and bonds
- fixed, equity-indexed, and/or variable annuities
- exchange-traded funds (ETFs)
- mutual funds
In short, you cannot invest in physical gold bullion (or any other precious metal) through a 403(b). Here is the easiest way to invest in gold. You can buy stocks from mining companies that will produce gold, or you can buy a mutual fund that includes those stocks. This is called buying paper gold. There are also mining ETFs that give people indirect access to investing.
Benefits of Rolling Over a 403(b) Plan to a Precious Metals IRA
A great benefit of rolling over your plan into a self-directed IRA is that you can control what type of investments are in the retirement plan and open up new tax-free investment opportunities – like precious metals.
The employer-funded retirement plan has limited investment options, which is helpful for those who don’t know where to start. In addition to this, the plan requires you to set up a vesting schedule that dictates how long it will be before you can get your hands on your funds. Self-directed IRAs stack up favorably against these other plans when it comes to flexibility.
Additionally, these plans are vulnerable to your employer’s risk. If they declare bankruptcy, you might lose the ability to contribute to your retirement plan.
When it comes to saving for retirement, you have a lot of options. For some people, the best choice is a 401(k) offered through their workplace. Others may prefer to invest in an IRA outside of work or even use both types of accounts simultaneously if they are eligible.
Depending on your situation and how much money you want to put away each year, one might be the better option over another. If you’re considering investing in a 403(b), there’s no harm in doing more research before making this decision.