A Complete Guide to the 403(b) Retirement Account

Retirement is something that we all hope to do someday. But in order to retire, you need to have enough money to support a lifestyle without a steady income from your job.

It all starts with contributing money to a retirement account and depending on what type of company you are employed by, you may have the option of using a 403(b) retirement account.

Retirement accounts can be a confusing topic because there are so many different options that are suitable for a variety of different situations. It is important to have an understanding of the options available to you so you can begin planning for your retirement.

If you are eligible for a 403(b), you’ve come to the right place. We are about to break down everything you need to know about this type of retirement plan.

What is a 403(b) Plan?

A 403(b) plan is a retirement account that is almost identical to a 401(k) retirement plan. The primary difference is that 403(b) plans are designed to serve employees of the public sector such as public schools or other tax-exempt organizations, whereas 401(k) plans serve employees of the private sector. 

A 403(b) plan is available to people such as teachers, school administrators, professors, government employees, nurses, doctors, and librarians.

Religious ministers may also participate in 403(b) retirement plans but it is important to note that they typically use a specialized 403(b)(9) plan.

How is a 403(b) Plan Different From a 401(k) Plan?

There are many more similarities between a 403(b) plan and a 401(k) plan than there are differences. Both of these accounts have the same annual contribution limits, different taxation options, and maximum employer/employee contribution limits.

However, there are a few major differences between these accounts that you should know about.

The first major difference is who is eligible to use a 403(b) plan. As we previously stated, a 403(b) retirement plan is designed for those who work in the public or tax-exempt sector rather than the private sector.

The second major difference is that 403(b) plans typically offer no employer match or they offer a very small employer match. This is due to legal complexities with how not-for-profit organizations operate.

In return, 403(b) plans typically vest sooner than 401(k) plans do, and if you have been employed for over 15 years, you can usually make extra catch-up contributions that you cannot make in a 401(k) plan.

The last important thing to note is that 403(b) plans typically have fewer investment options available than 401(k) plans. Due to the lower selection of investments, 403(b) plans will typically have higher expense ratios and fees.

If your 403(b) plan doesn’t offer low cost investment options, you may consider opening your own individual retirement account where you can make cheaper investments.

Important Things You Should Know About a 403(b) Plan

Now that we’ve covered the major differences between a 403(b) plan and a 401(k) plan, we can dive into important things you should know about this type of retirement account.

Maximum Contribution Limit

The maximum employee contribution limit for a 403(b) account in 2020 is $19,500. If you are over the age of 50, you can make a catch-up contribution of $6,500 for an aggregate total contribution of $26,000. 

Additionally, if your employer does offer a matching contribution, the maximum of all employee and employer contributions in 2020 is $57,000 or 100% of the employees most recent yearly salary. 

Taxation

A 403(b) retirement account offers two different taxation options just like a 401(k). Contributions can be made either pre- or post-tax. If your employer offers a Roth 403(b) you can make contributions post-tax. This means that when you withdraw the funds in retirement, you will not have to pay taxes on your withdrawals.

Alternatively, if you choose to make contributions pre-tax, you will offset your taxation in the current year, but you will be required to pay taxes on your withdrawals in retirement.

Whether you make your contributions pre- or post-tax is up to you, however, if you expect your salary to continue to go up, it is probably more beneficial to pay the taxes now so you aren’t taxed at a higher rate in the future.

Withdrawal Rules

In a 403(b) plan, you must wait until you are 59 ½ years old to make withdrawals without any penalties. However, if you retire at the age of 55, you may be eligible to make contributions without paying the penalty fee.

If you choose to withdraw funds before the age of 59 ½ you will incur a 10% penalty on your withdrawal. If you can avoid pulling money out of your retirement account, you should definitely do it. Only pull money out in situations of extreme financial need.

Pros and Cons of a 403(b) Plan

Just like every other retirement account, a 403(b) has both advantages and disadvantages. Having an understanding of these can help you determine if this is the right account for you.

Advantages of a 403(b) Plan

• 403(b) plans have a high contribution limit
• Employers can match a percentage of your contributions
• Contributions can be made either pre- or post-tax
• Investments grow tax-free

Disadvantages of a 403(b) Plan

• Will pay early withdrawal fees if you withdraw funds before age 59 ½ 
• 403(b) plans typically have less investment options than other retirement accounts
• 403(b) plans can have higher expense ratios and fees

Frequently Asked Questions

How Does a 403(b) Retirement Plan Work?

A 403(b) retirement plan works similarly to other types of employer-sponsored retirement plans. When you set up your account, you will select the investment options that you want your money invested in. You will also choose if you want your contributions to be made pre- or post-tax.

Money will then be deducted from each paycheck and invested in whichever investment options you chose when setting up your account.

Your investments will grow tax-free until they are withdrawn from your account.

You can make withdrawals without any penalty after the age of 59 ½ and may be required to pay income taxes depending on whether you paid taxes on your contributions or not. 

Can You Lose Money in a 403(b) Plan?

The short and simple answer is yes. Just like in any investment, you can always lose your money. Investing money through a 403(b) account is no different than any other investment. However, the investment options in a 403(b) plan will always be well diversified and have managers who have years of experience managing portfolios of investments.

This makes it very unlikely that you will lose money over the long run when investing in a retirement account like a 403(b). But, it is not completely impossible to lose money.

What Happens to My 403(b) When I Retire?

When you retire, your 403(b) remains in effect. The only thing that will change is that you will no longer be making regular contributions. Instead, you will be making withdrawals to fund your retirement. You may be forced to pay taxes on these withdrawals if you didn’t pay taxes on your contributions.

Another important thing to note is that you cannot make withdrawals without penalty before the age of 59 ½. You will also be required to make required minimum withdrawals once you reach the age of 70 ½.

How Much Tax Will I Pay if I Cash Out My 403(b)?

It depends how much you withdraw and when you withdraw the money. If you withdraw the money before the age of 59 ½, you will be required to pay a 10% penalty on your withdrawal plus income tax if your contributions were made pre-tax.

You should never withdraw money from your retirement account unless you absolutely have to because of a situation of extreme financial need.

Paying a 10% penalty on your withdrawal can have a huge impact on the long term value of your retirement account. It could be the difference of hundreds of thousands of dollars over the course of your career. Once you deposit that money, let it grow for as long as you possibly can.

How Much Should I Contribute to My 403(b)?

The amount you should contribute to your 403(b) will vary from person to person. However, a good rule of thumb is to try to contribute at least 10-20% of your income to your retirement account.

If contributing this much money to your 403(b) will make it difficult to cover the rest of your living expenses, then you may need to cut this back. It is important to put together a budget so you can see exactly how much money you can invest into your retirement.

If your employer offers a matching contribution, you should always contribute an amount up to that percentage to ensure that you get the full match. This is free money from your employer and is basically a bonus.

Always take the free money. It could have a huge impact on your savings when you do retire.

Can I Cash Out My 403(b) to Buy a House?

You can cash out your 403(b) to purchase a house. However, you may still be slapped with early withdrawal penalties and have to pay income taxes on your withdrawal. Therefore, it is often not worth it to take money out of your retirement account to purchase a house because it will end up costing you a lot more money.

If you cannot afford to make a down payment without dipping into your retirement savings, you may want to consider renting for a few years until you can afford to make a down payment.

Final Word

Retirement will be everyone’s largest expense that they incur in their lifetime. It is critically important to start planning for it early. Building good saving and investing habits while you are early in your career will make retirement much more attainable and comfortable.

If you are eligible to use a 403(b) plan, you should weigh the advantages and disadvantages and determine whether or not it is the right retirement vehicle for you. Regardless of which retirement account(s) you choose to use, just start making contributions as early and often as you can.

The greatest factor in how much money you will have for retirement is the amount of time your investments have to grow.

BIO:

Austin is the founder of The Logic of Money and has a passion for finance and helping others. He studied finance, investments, and banking as well as real estate and urban land economics in college. He hopes that he can share his knowledge and tips with others to help make personal finance less stressful for everyone.