A 403b and 401k retirement program look very similar. Both plans allow participants to set aside money for retirement on a pre-tax basis. Both plans take their names from the relevant tax code governing them. Both plans provide participants with significant sums of money for retirement.
Who is eligible to contribute to a 403b?
The biggest difference between the two plans is eligibility. While the 401k covers private-sector workers, only employees of public schools and certain tax-exempt organizations as determined by Section 501c3 of the Internal Revenue Code can participate in a 403b plan.
A qualified employer, in the eyes of the IRS, is an organization that is “organized and operated exclusively for religious, charitable, scientific, public-safety testing, literary, or educational purposes.” These types of institutions include K-12 public schools, colleges, universities, hospitals, libraries, philanthropic organizations, and churches.
What investment options are available to 403b participants?
Unlike the 401k, 403b participants cannot invest in individual stocks. Instead, their choices are:
- Annuity and variable annuity contracts with insurance companies.
- A custodial account made up of mutual funds. This is known as a 403b7.
- Retirement income accounts for churches.
How does a 403b work?
Participants set aside money on a pre-tax basis through a salary reduction agreement with their employer. The money is then directed to a financial institution selected by the employer. Like the 401k, the money grows tax-deferred until retirement. It is taxed as ordinary income when withdrawn.
Generally, 403b participants can only contribute to the vendors offered or sponsored by their employers. In many cases, especially at K-12 schools, these choices are really no choice at all.
How much can be contributed annually to a 403b?
Generally, the maximum contribution for tax year 2007 is $15,500 or 20% of salary, whichever is less. For employee and employer matching contributions the maximum is $45,000 or 25% of salary, whichever is less. If you are over the age of 50, there is a catch-up amount you can invest in addition to the maximum for each year.
Why is the 403b often called a TSA or TDA?
When the 403b was created in 1958, participants could only invest in annuity products, so the name Tax-Sheltered Annuity (TSA) or Tax-Deferred Annuity (TDA) took root. Despite the fact that Congress granted 403b participants mutual fund privileges in 1974, the TSA/TDA name remains very common today.
Can a 403b be rolled into an IRA?
Yes. This can occur when the participant:
- separates from service (job change),
- becomes disabled
Note: You are permitted to roll one 403b plan into another. But, you may not roll an IRA into a 403b.
What are the options for a 403b when switching jobs?
- Move the money into your new employer’s 403b plan. (Note, a 403b cannot be rolled into a 401k and vice versa.)
- Roll it into an IRA as mentioned above.
- 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.
When can 403b money be accessed without penalty?
Generally, penalty-free distribution from a 403b cannot occur until the
- Reaches age 59 1/2
- Separates from service (and must be retired)
- Becomes disabled
- Through a loan (some investment companies allow this, some don’t)