The Ultimate Guide to 403(b) Retirement Accounts

403(b)
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You’ve probably heard of a 401(k). Maybe you’ve heard of an IRA, too.

But swimming in that alphabet soup is yet another retirement savings plan — the 403(b).

So many letters. So many numbers. So many parentheses.

Maybe you’ve seen a 403(b) plan advertised as a workplace benefit while scoping out potential new jobs, or maybe you’re just curious about whether this retirement savings vehicle is something you should be paying attention to. Either way, we’ve got the lowdown on these plans.

Like other plans, a 403(b) is a great way to save for retirement, but it’s super important to read all of the fine print associated with the specific investment products you choose or you could end up paying some steep fees (more on that later).

Do I Qualify for a 403(b)?

A 403(b) is a voluntary retirement plan offered only by certain employers, primarily public schools, colleges, universities, hospitals and nonprofits, according to the IRS. It’s also available to some ministers. Bottom line: If you don’t work for a specific type of employer, or if you’re not working at all, you won’t be able to save using a 403(b).

These plans, created by Congress in 1958, were established to encourage employees to save for retirement. Though many teachers, nurses, professors and librarians are eligible for pensions, the payouts may not be enough for retirement. Enter the 403(b), which Congress intended to supplement those pensions.

These plans, named for a section of the tax code, are similar to 401(k) accounts. Like a 401(k), 403(b) plans are voluntary, meaning no one’s forcing you to contribute to one.

They’re also tax-deferred, which means you don’t have to pay taxes on your contributions or your investment earnings until you withdraw them at retirement. Making contributions to your 403(b) account now will lower your taxable income, which means you could see some savings when tax season rolls around.

In 2017, you can contribute up to $18,000 in pre-tax income to your 403(b) plan, according to the IRS. If you also contribute to certain other plans, such as a 401(k), the amount you can contribute to your 403(b) will be lower. Your pre-tax contributions to all of your accounts can’t exceed $18,000.

You can make additional contributions if you meet certain requirements laid out by the IRS. If you’ve worked for the organization for more than 15 years, you may be able to contribute an additional $3,000 annually for five years. If you’re 50 or older, you can make additional “catch-up” contributions of $6,000 per year.

Some employers will also contribute to your account with an employer match. The total annual contribution limit for your 403(b) is $54,000 or 100% of your “includible compensation,” whichever is lower. Includible compensation is the amount of taxable wages and benefits you earned in your most recent full year of work, according to the IRS.

Some plans allow you to make after-tax contributions, as well.

“I encourage employees to take advantage of the organization’s retirement plan first, particularly if there is a match. Who would turn down free money?” said Timothy Yee, president of Green Retirement Inc.

As is the case with a 401(k), you’re not supposed to withdraw money from your 403(b) until you’re 59 ½. The government will make certain exceptions to this rule if you get fired, die, become disabled, encounter financial hardship or are called to active military duty. You’ll pay a 10% federal early withdrawal penalty (and likely some state taxes, too) if you don’t qualify for one of these exceptions.

Before You Sign On The Dotted Line, Do Your Homework

You can have your money invested in annuities or mutual funds through your 403(b) account. An employer may let you choose between several providers and investment products. In California, public school workers can select from a mind-boggling 59 providers and more than 220 investment products, according to a recent New York Times investigation into these accounts.

Some experts argue that 403(b)s are confusing because employees can choose from dozens of providers and products. Daniel Pawlisch and William Ryan, who recently analyzed 403(b) accounts for Aon Hewitt Investment Consulting, said these plans “have created an environment that impairs retirement outcomes for participants.”

Some of these products are accompanied by steep fees and surrender charges, which you’ll face if you transfer your money into another product. Margaret Jusinski, a middle school teacher in New Jersey, paid more than $15,000 in fees and commissions on $87,000 in her 403(b) account, the New York Times investigation found.

Annuities, which are sold by insurance companies within 403(b)s and are so confusing even math teachers have a hard time understanding them, tend to have high fees.

“The 403(b) plan has normally been the domain of many insurance companies and their investment products typically have higher fee structures than non-insurance based plans,” according to Mark Zoril, founder of PlanVision. “403(b) plans have a reputation for being more costly, from an investment standpoint, than 401(k) plans. The employees — the participants — pay more than they likely otherwise would with a similar 401(k) plan.”

But it’s not just annuities that can be expensive. Some mutual fund products available through 403(b)s also come with steep fees, according to Scott Dauenhauer, a financial planner and the owner of Meridian Wealth Management.

“It doesn’t really matter what product you’re looking at. You have to be aware of what you’re buying, of what the fees are, if there are fees, what the surrender charges are, and how the adviser or the salesperson is being compensated,” Dauenhauer said.

Bottom line: Before you select an investment product, be sure to carefully inspect the associated fees, commissions and other charges. It may be worth your time to consult with an independent financial expert before making a decision — someone who isn’t earning a commission from the products you select.

“In the 401(k) world, there’s just one option,” he said. “There’s one 401(k) (offered by your employer), and the only research you have to do is what are your investment options. It’s a lot simpler than 403(b)s. There’s just too much choice. It really paralyzes people.”

Dauenhauer also suggests posting a list of the vendors and products offered through your 403(b) to the forum on 403bwise.com. The online chat board, which has thousands of threads, harnesses the collective knowledge of the teachers, nurses, librarians and other 403(b) users across the country.

“Literally within hours or a day, there’s going to be a response from somebody on that message board saying, ‘Avoid this. Avoid that. Oh by the way this option is usually a bad option, but if you do XYZ, you can get into a decent option,’” he said.

403(b) or IRA?

Still, if your choice is between a 403(b) and an IRA (traditional or Roth), there are some things to consider, chief among them the contribution limits for each type of retirement plan.

With its $18,000 pre-tax contribution limit, the 403(b) plan may be a better choice for folks who believe they can save more than the $5,500 IRA annual contribution limit. There’s also the employer match that may come with a 403(b) plan — you have no chance at free money with an IRA.

Don’t let all of these options convince you that it’s best to just throw in the towel altogether, said Dauenhauer. Whatever you do, save early and save often.

Your Turn: What do you think of your workplace retirement savings options?

Sarah Kuta is an education reporter in Boulder, Colorado, with a penchant for weekend thrifting, furniture refurbishment and good deals. Find her on Twitter: @sarahkuta.