What is a 403(b)? The 403(b) is a tax deferred retirement plan available to employees of educational institutions and certain non-profit organizations as determined by section 501(c)(3) of the Internal Revenue Code. Contributions and investment earnings in a 403(b) grow tax deferred until withdrawal (assumed to be retirement), at which time they are taxed as ordinary income. See IRS Publication 571 for IRS details on the 403(b). You can also obtain this document by calling 1-800-829-3676.   When was the 403(b) established? The 403(b) was established in 1958 by the federal government to encourage employees in certain tax-exempt organizations to establish retirement savings programs. The name refers to the relevant section in the Internal Revenue Code.   Who can contribute to a 403(b)? Employees of tax-exempt organizations established under section 501(c)(3) of the Internal Revenue Code. These organizations are usually referred to as section 501(c)(3) organizations or simply 501(c)(3) organizations. Participants include teachers, school administrators, school personnel, nurses, doctors, professors, researchers, librarians, and ministers. See IRS Publication 557 for details on 501(c)(3) organizations.   Why Contribute to a 403(b)? A Healthy Retirement - Most employees of educational institutions and other non-profit organizations are provided with a pension upon retirement. Few pension plans, however, provide an amount equal to salary. A 403(b) plan can provide a healthy supplement to a pension.   Lower Taxes - 403(b) contributions are made on a pre-tax basis which can greatly reduce your tax bill. Generally, if you contribute $100 a month to a 403(b) plan, you've reduced your Federal income taxes by roughly $27 (assuming you are in the 27% tax bracket). In effect, your $100 contribution costs you only $73 The tax savings are magnified as your 403(b) contribution increases.   More Tax Savings - all dividends, interest and capital gains accumulate in a 403(b) account on a tax-deferred basis. This means your earnings will grow tax-free until time of withdrawal.   How does a 403(b) plan work? You set aside money for retirement on a pre tax basis through a salary reduction agreement with your employer. You choose from among the vendors offered by your employer where your money is to be invested. The money grows tax free until withdrawal at retirement.   Will participation in a 403(b) plan reduce Social Security benefits? No. Salary reduction contributions to a 403(b) reduce taxable compensation for federal (and in most instances, state) income tax purposes only. Those contributions do not reduce wages for the purpose of determining FICA taxes or determining social security benefits.   Will participation in a defined contribution plan such as CalSTRS in California or TRS in Texas affect one's ability to contribute the maximum elective deferral limit to a 403(b) plan? No. The elective deferral limit is a taxpayer limit, meaning that your maximum contribution to all plans cannot exceed the annual limit. However, your mandatory contribution to the state defined contribution plan is not considered an elective deferral, so it doesn't reduce your annual limit. Therefore, you are able to participate in your state's defined benefit plan and contribute the maximum allowable to your 403(b) plan.   Are part time employees eligible to contribute to a 403(b)? In order to meet nondiscrimination requirements of the law, once a plan sponsor permits any employee to elect a salary deferral into the TSA, the opportunity must be extended to all employees of the organization who may elect to have the plan sponsor make contributions of more than $200 pursuant to a salary reduction agreement. This is known as universal availability. However, certain employees may be excluded. Employees who may be excluded include employees who are participants in an eligible deferred compensation plan [457 or 401(k)] or participants in another TSA, non-resident aliens, certain students and employees who normally work less than 20 hours per week. Employers must take special care to comply with this requirement. Non-compliance could result in the entire 403(b)/TSA losing its tax-favored treatment.   What does a 403(b) plan cost and who is paying for it? Typically, the plan has two kinds of expenses: administrative costs and investment management fees. Investment management fees are usually charged by the investment company as a percentage of the total assets under management — the total value of your account. These fees range from about 0.2% on the low end to 3% on the high end. For example, if you had $100 invested, a fee of 0.2% would cost you 20 cents a year, while a fee of 3% would cost you $3 a year. See: Fees and How They Affect Your 403(b).   How much can I contribute annually? For 2003, workers are able to contribute:   1. the new elective deferral limit of $12,000 (going up to $13,000 in 2004), or   2. up to 100% of compensation (must be less than the elective deferral limit), or   3. for those with employer matches, limits are $40,000 or 100% of compensation (lesser amount). Note: the employee is still limited to the employee elective deferral limit ($12,000 for 2003). An employer can add up to another $28,000.   4. in addition, if you are 50 or older at any time during 2003, you may contribute an additional $2,000.   Note: a special 15 years of service catch-up election, known as the 15-year-rule, will remain in place. This special "catch-up" provision allows you to increase your annual contribution by $3,000 more than the current $12,000 limit (as of 2003). To qualify you must have completed at least 15 years of service with the same employer (years of service need not be consecutive), and you cannot have contributed more than an average of $5,000 in previous years. Contributions made under this catch-up provision cannot exceed $3,000 per year, up to a $15,000 lifetime maximum (under current rules). Consulting a tax professional before participating in this provision is highly recommended.   Contribution Calculators See the calculators in our ResearchWise section   What investment options are available to 403(b) participants?   1. Annuity and variable annuity contracts with insurance companies   2. Custodial account made up of mutual funds. This is known as a 403(b)(7)   3. Retirement income accounts for churches     What's the difference between an annuity and a mutual fund? An annuity is an insurance company contract that can be used for accumulating assets for retirement or as a method of providing an income stream at some future date. Fixed annuities guarantee your principal and a fixed rate of return and they are generally considered conservative and stable. A variable annuity's value will fluctuate because it is dependent upon the performance of the underlying investment options managed in the separate account. A mutual fund is a "pooled" investment. You can think of it as a group of people with similar investment goals who all get together and put some of their money in a single "pot". A professional money manager is hired to invest the money in stocks, bonds, and/or short-term investments.   Mutual funds are pools of money invested in many different securities and are managed according to set objectives. They are similar to the investments underlying variable annuities, but do not have the associated insurance fees of an annuity. With mutual funds, you can choose among aggressive funds for growth to more conservative funds for stability similar to that of a fixed annuity. When comparing similar investments, it is important to consider all factors of an investment, including performance, fees, risk, flexibility, time horizon and your own confidence in the investment or insurance company.   Additional Resources: Variable Annuities: What You Should Know [SEC]   Invest Wisely: An Introduction to Mutual Funds [SEC]   Before committing to any 403(b) investment option, what questions should I ask? The following recommendations come from Mutual Fund Magazine's Making More of Your 403(b)     1. Will I be penalized for pulling my money out? "This is the most important question you can ask," says Marianne Shine, a certified financial planner in Deerfield Beach, Fla. Annuities typically penalize investors who bail out. During the first few years of the contract, you may have to pay surrender charges if you transfer your money elsewhere. Often the surrender fees start at 7% or 8% and decline by a percentage point every year. If you switch employers and move the money out of an annuity with a surrender charge, you will have to pay the penalty. Certain surrender fees, however, refuse to vanish. You'll typically discover this nasty surprise with "two-tier" annuities. With one of these, you'll pay a penalty if you decide not to annuitize your payments upon retirement. If you prefer to withdraw your money and invest it elsewhere, you can, in some cases, face a 20% or higher penalty. Unless you're approaching retirement age, it's best to flee from a two-tier annuity, Shine advises.     2. What are my investment choices? The underlying investments within a variable annuity will be mutual funds. An insurance agent will probably refer to them as "subaccounts." What is the performance record of these funds? How does each compare with its appropriate benchmark? If a large-cap growth fund has consistently under performed the Standard & Poor's 500 Index, for example, stay away.     3. What annual fees will I pay? You should check the yearly expense ratios for annuities as well as traditional mutual funds. Fees can dramatically erode returns over time.     4. How is an insurance company rated? If you are investing in a fixed annuity, you need to know how financially sound the insurance carrier is. You'll want to review the ratings from at least two insurance-rating services such as A.M. Best, Moody's, and Duff & Phelps. You might assume that your money is protected within a fixed annuity, but there's no real guarantee. That's because the money in a fixed annuity is not segregated and therefore can be at risk if the insurer declares bankruptcy.     How do I set up a 403(b)? Ask your employer for a list of the participating investment companies available to you. This is typically known as the vendor list. Select several investment companies from this list. Then, most importantly, research these choices with an eye toward performance and cost. Next, determine the amount of money you wish to contribute monthly. Most companies require at least $50 per month. Finally, return to your employer with the necessary investment paperwork and you're on your way. For more information see: Start a 403(b)   Do I have to use an agent to set up a 403(b)? No. This site believes that with financial education, patience and realistic expectations, individuals are perfectly capable of managing their own 403(b). It is important to point out, however, that many agents provide valuable services to their clients. These services can include: retirement planning, information about state retirement plans, and analysis of other financial needs. Such agents rightly deserve to be compensated for their services. The key is to figure out exactly what services you are receiving, and exactly what fees you are paying for these services. Only then can you determine the true value of using an agent. Other options include hiring a financial planner who can be paid on an hourly basis to aid you with your 403(b).   Can I change the amount I contribute? Yes. But you might have to wait for a specific date. Some employers limit the number of changes during a year. It's best to ask about this before you begin contributing.   Can I stop contributing altogether? Yes. You may stop contributing at any time.   How long after my 403(b) contribution is deducted from my paycheck should it take for it to be credited to my 403(b) account? Employers are required to transmit employee contributions to retirement plans as soon as they can reasonably be segregated from the employer's general assets, but not later than the 15th business day of the month immediately after the month in which the contributions were withheld or received by the employer.   What investment companies can I invest with? Your employer can provide you with a list of the companies which they have approved for participation.   Can I invest in a vendor of my choice? If your preferred vendor is not currently on your employer's list, request that it be added. This may be all it takes. Cooperation and regulations vary among employers. In some cases, more intense lobbying will be required. See: Get Better 403(b) Choices [403(b)wise] 7 Ways to Lobby for a Better 401k Plan [SmartMoney]   You may want to download a copy of the 403(b)wise 403(b)ill of Rights. It's a wish list of options and services many in the 403(b) community would like to see. Click 403(b)ill of Rights.   What is a "Hold Harmless" Agreement? A legal agreement that some school districts demand financial providers sign in order sell 403(b) products. Many mutual fund companies object to these agreements and choose instead not to offer their products to these districts.   What if I'm not sure my company qualifies for 403(b) participation? The IRS operates an educational outreach program called Section 403(b) Tax Sheltered Annuity Partnership for Compliance. The goal of this program is to increase understanding and compliance with the tax law as it relates to section 403(b). Under this partnership, trained and experienced IRS employees are available to provide 403(b) educational services including: delivering speeches, participating in panel discussions, conducting training sessions and helping prepare newsletter articles. You can obtain more information about this program by clicking on 403(b) IRS Educational Outreach.   Do I need my employer's consent to contribute to a 403(b)? Yes. Your employer must agree to make contributions to your 403(b) in accordance with a salary reduction agreement. This is an agreement between the employer and employee under which the employee agrees to take a reduction in salary or to forego a salary increase and the employer contributes that amount to a 403(b) for that employee.   How is a 403(b) different from a TSA (tax-sheltered annuity)? As far as the IRS is concerned a 403(b) is a TSA, and a TSA is a 403(b). The terms are interchangeable. Either way, participants can contribute to annuities, variable annuities or mutual funds.   How is a 403(b) different from a 401(a)? The main difference between a 401(a) and a 403(b) is eligibility. A 401(a) can be established just for administrative staff, or even as narrowly defined as for the caffeteria workers only. A 403(b) on the other hand requires universal availability.   How is a 403(b) different from a 401(k)? The 401(k) is a tax-deferred retirement plan for private sector employees, while the 403(b) is a tax-deferred retirement plan for employees of educational institutions and certain non-profit organizations. There are other differences. For more information see: How Do 403(b) Plans Compare to 401(k) Plans? [TIAA-CREF]   What is a 403(b)(7)? The IRS created the 403(b) in 1958. In 1974 Congress added paragraph (7) which allowed employees to set up retirement plans directly with mutual fund companies. Prior to this change contributors were limited to investment choices offered by insurance companies. Throughout this site the term 403(b) is intended to mean all of the following: 403(b), 403(b)(7) and TSA.   When can 403(b) money be accessed without penalty? Generally, penalty-free distribution from a 403(b) cannot occur until the participant:   Reaches age 59 1/2   Separates from service in the year turning 55 (and must be retired)   Retire before age 55 — eligible for Substantially Equal Periodic Payments (SEPP). Participants who have retired early (before age 55), but want access to their 403(b) without penalty can do so using SEPP. This provision requires that you take a series of substantially equal periodic payments. The key is that once you start these payments they must continue for five years or until you reach 59 1/2, whichever takes longer. If you start at age 58 you must continue until you are 63 (minimum 5 years).   Becomes disabled   Through a loan (some investment companies allow this, some don't)   Suffers financial hardship   Dies     Consulting a tax professional before accessing 403(b) money is highly recommended.   Loans Another way to access 403(b) money early is to take out a loan. Though not all vendors oblige, loans are permitted from a 403(b). Many mutual funds do not allow loans. This can be both an advantage and a disadvantage. The advantage is that access to your funds is limited and you are less likely to take out a loan, thus allowing your money to continue to grow. The disadvantage is that you may really need the money and the only way to get it is through a hardship withdrawal which has tax consequences (explained below). Other rules governing loans exist but vary by vendor, so consult your vendor for details. You may also want to read this story on loans: The 403(b) Loan: The New Debtors Prison?.   Consulting a tax professional before taking out a 403(b) loan is highly recommended.   Under what circumstances may a hardship withdrawal be made? This provision allows withdrawal of funds from a 403(b) if under severe financial distress. The participant must have no other resources available. A hardship withdrawal may be made for:   Un-reimbursed medical expenses of the participant or his/her spouse and dependents.   Down payment on primary residence.   Tuition and fees for higher education needs, and only for the next 12 months.   Eviction or foreclosure on your primary residence     Hardship withdrawals are not exempt from an IRS 10% penalty. Furthermore, withdrawals are subject to ordinary income taxation in the year withdrawn. To qualify you must certify that you have no other recourse, including the possibility of taking a loan. You also are prohibited from contributing to a 403(b) for the next six months. The IRS makes it tough to access money this way for a reason: they don't want you to use the 403(b) as a form of short term savings. For exact details on your situation it is recommended that you contact both your vendor and a tax professional before proceeding.   Also, while the IRS permits withdrawals, it is allowable for a plan sponsors (the employer) to not permit them. The employer has some responsibility in making hardship withdrawals. The employer has to "OK" the hardship, based on written information provided by the employee as to the nature of the hardship. The employer has to determine, based on the facts, whether the employee has an "immediate and heavy financial need."   Consulting a tax professional before making a hardship withdrawal is highly recommended.   What are the options for a 403(b) when switching jobs?   1. Move the money into your new employer's 403(b) plan. (Note, as of 2002 a 403(b) can be rolled into a 401(k) and vice versa. Not all plans allow such transfers, so check with your employer and plan provider.)   2. Roll it into an IRA. See: Rolling a 403(b) into an IRA   3. Leave it where it is, especially if you like your investment choices. If the balance is below $5,000 some employers require you to move the money. Check with your employer.   4. Take a lump sum payment. Beware! This is not Wise at all. This will trigger all kinds of fees and penalties, and worse, ridicule and scorn from your Wise friends.     For more detailed information refer to IRS Publication 571. You can obtain this document by calling 1-800-829-3676 or it may be downloaded by clicking on IRS Publication 571.   How will distributions from my 403(b) be taxed? In most cases, the payments you receive, or that are made available to you from a 403(b) are taxable in full as ordinary income. In general, the same tax rules apply to distribution from a 403(b) that apply to distributions from other retirement plans. For more detailed information refer to IRS Publication 571. For your specific situation it's recommended that you consult a professional tax advisor.   Can I leave my money in the plan indefinitely? No. The federal government will allow you to put off paying taxes on the money for only so long. Generally, you must begin to take withdrawals no later than April 1 of the year following the year in which you turn age 70 1/2.   What about distribution requirements for 403(b) money contributed prior to December 31, 1986? 403(b) account balances that existed on December 31, 1986 are not subject to the age 70 1/2 distribution requirement. However, any earnings on that balance are. Distribution from the 12/31/86 balance needs to start at age 75. This requirement is not found in the Internal Revenue Code, but rather in a letter ruling. Also, any distributions in excess of required distributions are deemed to reduce the 12/31/86 balance. So, if any money has been taken out of the 403(b) account other than those that are required (such as a partial withdrawal or a deemed distribution), the 12/31/86 balance may be less than anticipated. For your specific situation it's recommended that you consult a professional tax advisor.   What other 403(b) resources does the IRS offer? The IRS has an online IRC 403(b)/457 Online Resource Guide.   What other reading material do you recommend? IRS Publishes Frequently Asked Questions on TSAs/403(b)s Excerpt: "I am going to retire at the end of the current year. I did the catch-up computations under special catch-up rules for the year of separation from service contribution limit. I have not made a prior catch-up election. My figures indicate that I can put away $30,000 in my final year. My contribution is all salary deferral with no employer discretionary or matching contribution. Can I make the election and defer the entire $30,000?"   Top Ten 403(b) Must Reads [403(b)wise]   If you have additional questions post them at: 403(b)wise Message Board   To the best of our knowledge, we believe all of the information contained on this page to be accurate. Always get a second opinion and check other sources before taking any action. We also recommend that you read our Disclaimer.   Thanks to Vincent D. Tate, author of the The Complete Teacher's Guide to Retirement Wealth, for help in compiling this resource.     Home | Disclaimer | © 2001-2003 bWise Guys, LLC. All rights reserved.				New edition The 403(b) Wise Guide now available