Yes, there is a 401(k), Roth IRA, and other commonly-talked about accounts.
But what about options for someone in the non-profit space?
That’s where a 403(b) comes in – it’s an excellent option as a retirement account for those who qualify. In this article, I’ll share more about what a 403(b) is, who qualifies, and how to best manage yours.
What is a 403(b)?
A 403(b) plan is a retirement account for certain employees of public schools and tax-exempt associations. Participants include government workers, college administrators, professors, teachers, nurses, physicians, and librarians.
Most of us have heard of a 401(k), however, the 403(b) is equally as powerful as a retirement tool. Both accounts are alike, but there are a couple of differences in contribution limits and eligibility requirements it’s worth knowing about.
How does a 403(b) work?
As I said above, a 403(b) is much like a 401(k), with differences in eligibility and contribution limits. Like a 401(k), you’ll choose your investments.
Here are some things to know about how a 403(b) works:
A 403(b) plan is available to only certain groups. You’re eligible if you’re a minister or employee of a hospital, specific schools, or a non-profit organization. To be more specific, you can participate in a 403(b) plan if you belong to:
- An employee of a public school system, organized by a Native American tribal government.
- An employee of a cooperative hospital service organization.
- An employee of a public school system – someone who participates in the daily operations of a school.
- An employee of an organization that is tax-exempt as per the IRS’ Section 501(c)(3).
Does this mean employers cannot use a 401(k) plan? They do have the option, but they go for the 403(b) plan for a reason – it has cheaper administrative expenses.
If you’re eligible, go for a 403(b) plan. For that, you’ll probably need to contact Human Resources. Many companies let you enroll online nowadays, too. As you’re doing this, though, there are a few things to think about:
How much should you contribute?
To begin with, let’s face one of the most crucial questions: how much money should I contribute? Usually, you have the option to either pay a fixed dollar amount or invest some percentage of your monthly salary.
After you have figured out the money, it’s the role of your employer to withhold it and see that the amount is sent to the relevant financial institution. Each financial institution has its own packages, which I’ll discuss later in the guide.
If your employers add any further contributions to your account, it will also be deposited in your 403(b) account.
Now let’s look at the contribution limit. For 2020, if you’re under 50, you can invest as much as $19,500 per year. If you’re over 50, you can invest $26,000. If you’ve chosen a percentage-based contribution model, your employer will typically stop withholding your money after it meets the limit.
If you can swing it, I strongly recommend maxing out your 403(b), especially if you’re getting an employer match. It reduces your taxable income and plays into the automated investment strategy I’ve been talking about.
Choosing the right investments
Once you start contributing, you’ll have to pick your investments. Your employer will give you different options to choose from, but ultimately, it depends on your 403(b) plan.
For example, an insurance company may provide you with an individual annuity contract where you can get fixed annuities generating money at either specific interest rates or variable annuities. These are connected to different assets like bonds and stocks.
Some plans are also known as a custodial 403(b) account; they provide mutual funds as investment options. If you’re a church employee, you can typically go for either mutual funds or annuities.
When it comes to 403(b) plans, it’s essential to take your time and formulate a well-thought plan. I strongly recommend you create a diversified portfolio where your retirement investments include income-based options like bonds and growth-based ones like stocks.
However, the costs and fees of these investments will differ. Don’t always go for the cheapest option if it’s not right for you. Make sure you check out the expense ratio, which is essentially how much you’re paying the broker to manage that fund. Remember, though, the less you pay in fees, the more money goes back into your pocket.
The key is to strike a balance between a low-cost investment option that can also provide you with attractive returns.
Withdrawing from a 403(b)
A 403(b) is meant to be a retirement account – so you can withdraw money once you reach the appropriate age and begin your post-work life. But there are some things you should know about withdrawals.
You can withdraw your entire account when you turn 59 1/2
For example, once you reach 59 ½, you can withdraw your entire amount at once without penalty. Similarly, you can create periodic withdrawal schedules, which fit the requirements of your cash flow. This means you can withdraw a certain amount on a monthly, quarterly, bi-yearly, or yearly basis. Those with annuity-based accounts can tailor their payouts with additional flexibility.
I don’t recommend this option, though. If you’re going to withdraw everything, you should be doing this to roll it into another investment account (see below) to continue growing those funds.
Otherwise, I would suggest you follow the 4% rule – withdraw 4% per year to live off of. In many cases, you can keep your principal balance in place while living off of interest with this method.
Rolling your balance to an IRA
Some people also go for the other option – rolling their balance to an individual retirement account (IRA). This option is beneficial for those who have less than ideal investments in their 403(b) plans.
They leverage IRAs for reinvesting their savings in a broader spectrum of profitable investments, and the best part is there are no immediate taxation consequences.
403(b) plans boast a strong reputation due to the array of tax benefits they provide. For instance, one of its significant advantages is that it can help you to contribute pre-tax. This means that your contribution is not taxed for that year, and thus you get to pay lower taxes.
Similarly, another advantage is that your 403(b) money grows on a tax-deferred basis. You’re not forced to pay taxes for your 403(b) payments from dividends, interests, or investment income.
Who should use a 403(b)?
As I outlined above, a 403(b) has specific eligibility requirements – meaning not everyone can participate. Here are a few things to think about before going full-force into your organization’s 403(b):
- Matching – Does your company offer a match? If not, it may not be worth investing here. If so, you should probably invest to at least meet the company match.
- Savings rates – Most organizations will now auto-enroll you in the 403(b) – but at a low percentage (i.e., 2-3 percent). This won’t often be enough to retire on, so you’ll need to be mindful of the defaults and be comfortable increasing those.
- Investment types – Your 403(b) should have stocks and bonds to invest in. If not, it might be a red flag.
403(b) plans are more of a mixed bag because of the absence of minimal ERISA criteria, whereas 401(k) plans generally have a greater bar. They may be a fantastic way to save for retirement if matching is provided and the investment choices are high and costs are low.
403(b) plans are usually similar to the principles of 401(k) plans, but there can be flexibility about withdrawals and catch-up contributions for longer-term workers.
Where to get a 403(b)
While you may not always have the choice of who services your 403(b), I want to outline some of the best ones so you can tailor your approach when investing.
Meaning, if you have a 403(b) with a less-than-reputable company, you might not want to max everything out and instead put money in an IRA or into a taxable investment account with a robo-advisor.
Here are the best 403(b) servicers – all of whom you can also open up additional investment accounts.
Vanguard is one of the most well-known 403(b) providers. It boasts a strong reputation as the largest mutual fund organization of the world and manages assets worth $4.5 trillion.
If you’re a 403(b) customer, you can choose from around 50 different mutual funds from Vanguard – all are managed by professionals. Following are some of the investments that can you can choose with Vanguard:
- Money market mutual funds.
- Equity funds.
- Target date funds.
- International funds.
- Bond Funds.
These are the costs you’ll find with Vanguard’s 403(b):
- Annual fund expense ratio – With only 0.12% average per fund, Vanguard offers one of the lowest charges in the industry. These fees are deducted from the funds to pay for the fund management and trading expenses.
- Recordkeeping fee – You have to pay $60 per year for all the recordkeeping that is performed by Vanguard at your behest.
- Lending fees – In plans that facilitate participants to borrow against their retirement assets, they pay $50 when they get a loan and $25 per year whenever the loan has an outstanding balance.
Fidelity manages stock worth $2.5 trillion. It’s singled out by those who can pay premium charges for high-quality financial services. You can benefit from the following investment options:
- Bond funds.
- Money market mutual funds.
- Target date funds.
- Target allocation mutual funds.
- High-yield bond funds.
If you have gone along with a Fidelity 403(b), you have to pay these fees:
- An annual fee for record-keeping and account maintenance.
- Mutual funds of their 403(b) have costs associated with account management and trading with an expense ratio beginning from 0.05% and ending at 1.25%.
- Each participant is charged $24 each year for having a 403(b) account.
A 403(b) is not a fool-proof retirement plan; it has its downsides too. However, there is a reason it’s preferred over 401(k) plans. It’s easy for employees and their employers to make sense of has significant maximum contribution limits, and can get you attractive tax benefits.
If you’re eligible for a 403(b), you absolutely should talk to your HR representative to see if it offers what you’re looking for.
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