The 403(b) plan is set up very similar to the 401(k), except it’s designed for a different employer.

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In most respects, it works the same way as the 401(k).

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That includes:

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The same contribution limits, withdrawal provisions and required minimum distributions.

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But there are two important respects in which 403(b) plans depart from 401(k)s.

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The first is that the 403(b) plan does not hold the potential to offer a profit-sharing arrangement. Fundamentally, this is because the 403(b) is offered specifically by non-profit organizations and government agencies that do not produce profits.

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Under a very generous 401(k) plan, a profit-sharing plan may be offered that will allow employees to receive up to 25% of their income in profit-sharing, up to a maximum of $57,000 per employee. However, this benefit is offered by only some 401(k) plans, and is hardly universal.

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The other major difference is that 403(b) are not subject to income discrimination rules. 401(k) plans are subject to income limitations imposed under highly compensated employees, or HCEs.

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The short explanation is:

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Employees who own at least 5% of the business, earn at least $130,000 per year and are in the top 20% of employees by pay will see their contributions limited.

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Employer Matching Contributions Unlikely

 

However, the absence of the HCE restriction only applies if the employer does not make a matching contribution.

 

If they do, the HCE restriction applies.

 

This is why very few employers offering the 403(b) plan make a matching contribution.

 

More Limited Investment Options

 

403(b) plans are typically set up like annuities and run by insurance companies.

 

That will limit your investment options to those offered by the insurance company, if you’ll have any flexibility in that area at all.

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Additional Information: Pertains to 401K's, 403B's and 457B's

 

In most cases, you won’t have a choice as to which plan you’ll participate in.

 

That's to say:

 

Your choice is determined by the type of employer you work for.

 

If it’s a private, for-profit corporation or business, you’ll most likely be offered the 401(k) plan. But if it’s a non-profit or government agency, you may be offered either the 403(b) or 457 plan.

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However, a very limited number of government agencies offer a 401(k) in addition to either a 403(b) or 457 plan.

And in some cases you may have different plans with different employers.

 

For example, you may begin the year with a government agency that offers a 457 plan and end the year with a private corporation offering a 401(k) plan.

 

If you have an opportunity to participate in both plans, the maximum annual combination of contributions will be $57,000, or $63,500 if you are 50 or older. That includes your own regular contributions, catch-up contributions, and any employer matching contributions.

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How to Best Manage Your 401(k), 403(b) or 457 Plan

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Contribute Regularly

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If your employer offers any of the above three plans, you should participate.

 

Even if you’re covered by a defined benefit pension plan – which few workers are these days – a tax-deferred retirement savings plan can be an excellent supplement to a regular pension and monthly Social Security check.

 

By contributing as much as you can, you’ll not only get the benefit of a lower annual tax bill, but you’ll build a large retirement nest egg more quickly.

 

If that’s done early in your life and consistently thereafter, it may eventually open the opportunity to early retirement.

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Employer Matching Contributions

 

This applies primarily to 401(k) plan participants. But even then, employers are not required to offer a matching contribution, though many do.

 

So:

 

At a minimum, you should make the smallest contribution you can to get the largest employer match.

 

For example, if your employer will match 50% of your contribution, up to 3% of your salary, you should contribute at least 6% of your pay to the plan. That will not only maximize the employer matching contribution, but also get you an effective 9% annual contribution rate.

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Explore Roth Options

 

Many employers offering any of the three plans also provide a Roth option.

 

If offered, your contributions to the Roth portion will not be tax-deductible.

 

However, investment income will accumulate in the plan on the tax-deferred basis.

 

Upon reaching age 59 ½ – and if you’ve participated in the plan for a minimum of five years – you’ll be able to begin taking distributions from the Roth portion of your plan on a tax-free basis.

 

It’s an excellent strategy to create tax diversified retirement income.

 

If an employer does offer a Roth option, you’ll generally be given the ability to determine how much of your plan contribution will go to the regular plan and how much to the Roth portion.

 

But if you choose, you’ll be able to direct up to 100% of your total contributions into the Roth portion.

 

One factor to be aware of however is the employer match.

 

If the employer does match your contribution to the Roth portion, it will not go into your Roth account. Instead, it will be placed into a regular plan, even if you don’t have one in place. That’s because while your own contributions to a Roth account can potentially be withdrawn tax-free, employer matching contributions cannot.

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Be Careful of Loan Provisions

 

An employer can offer a loan provision on any of the three plans, but it’s not required to do so by the IRS.

 

If a loan provision is offered, it’s limited to not more than 50% of your vested plan balance, up to a maximum of $50,000. It must generally be repaid in not more than five years.

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But as convenient as retirement plan loans are, use them sparingly. Even if they are technically “paying interest to yourself”, that “return” is generally lower than what you’ll earn on other investments.

 

Furthermore:

 

Since part of your retirement contributions will be going toward loan repayment, this will reduce the future value of your plan.

 

Also be aware that if you terminate your employment before the loan is repaid, you’ll be required to repay the loan proceeds within 60 days of departure.

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If not, the employer is required to consider the unpaid portion of the loan to be a distribution.

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Not only will it be subject to ordinary income tax, but also the 10% early withdrawal penalty tax if you are under age 59 ½.

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What Happens to Your Plan When You Terminate Your Employment?

 

Whether you have a 401(k), 403(b) or 457 plan, you’ll be given one of four options when you terminate your employment:

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• Keep the plan where it is.

• Roll the plan over to a comparable plan with a new employer.

• Roll the plan over to a traditional IRA account.

• Take distribution of the plan funds personally.

 

If you choose one of the first three options, there’ll be no tax consequences.

 

But if you choose the fourth option, the total amount of the distributed funds will be subject to ordinary income tax, as well as the 10% early withdrawal penalty if you’re under age 59 ½.

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Final Thoughts

 

401(k), 403(b) and 457 plans are among the most generous defined contribution plans available.

 

If offered by your employer, you should take full advantage.

 

Invest as much as you can, as early as you can, since that will create the greatest growth in your plan.

 

If you heavily fund your plan early in life, you may have sufficient funds that you can either reduce future contributions or eliminate them entirely.

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-End of Article by Kevin Mercadante

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