One of the best things you can do for your future self is to save for retirement. Unfortunately, according to recent research, about one-third of Americans have $5,000 or less set aside for retirement. It’s never too early to start thinking about your financial future, and your retirement savings are key.
If you’re looking for a way to sock money away for retirement, your 403(b) plan could be just what you need. These retirement plans are offered by employers in the nonprofit sector, as well as in some other careers, like public education and healthcare. Here’s what to expect if your employer offers a 403(b) plan.
A 403(b) is sometimes also called a Tax-Sheltered Annuity (TSA) plan. For practical purposes, it’s basically a 401(k) plan for people who work for qualifying tax-exempt organizations, certain hospital organizations, or employees of public schools. Government employees, church workers, and even librarians might also have access to a 403(b) plan.
Your employer chooses what type of plan they are willing to offer, so you can’t choose to participate in a 401(k) instead. Your 403(b) plan will come with different investment options, usually in the form of mutual funds that allow you to create a portfolio that matches your risk tolerance.
However, it’s important to understand that the annuity agreement involved makes for a couple of tricky situations that might not apply to other retirement plans:
- Withdrawals are subject to a 20 percent federal income tax withholding, except in specific circumstances.
- To dissolve the annuity investment aspect of a 403(b), there might be a surrender charge of up to 8 percent.
Speaking with a professional to help you with these situations can help you navigate some of the quirks involved.
How Does a 403(b) Work?
In many cases, your employer will automatically deduct your contributions to the 403(b) from your paycheck. This deduction is usually expressed as a percentage. If you make $2,500 each paycheck, and you want your employer to withhold 4 percent of your income, $100 will be diverted to your retirement account each payday.
If you choose a traditional 403(b) arrangement, your contribution will be deducted from your pay before taxes are figured. This reduces your tax bill today, but you’ll still have to pay taxes when you withdraw money later. On the other hand, your employer might offer a Roth option, which doesn’t result in a tax benefit today. Instead, your money grows tax-free and you won’t have to pay taxes when you withdraw.
Some employers also match your contributions. They may match a certain percentage of your income, or they may offer a dollar-for-dollar match up to a cap. Either way, an employer match on your plan is free money that you can put toward your retirement.
The money grows over time, thanks to compounding returns, and you have a chance to build wealth so you have financial resources when you quit working. It’s possible to adjust how much you save by letting your human resources representative know, or by managing your contributions through your employer’s online benefits portal.
403(b) Contribution Limits
The government wants to encourage retirement saving, and so offers tax advantages when you contribute to a 403(b) plan. However, you can’t just put everything into a tax-advantaged plan. Your 403(b) comes with limits.
For 2020, you can contribute up to $19,500 a year, which is a $500 increase over the 2019 limit. If you’re age 50 or over, you can make extra contributions totaling $6,500 a year in 2020. The IRS also allows for additional catch-up contributions if you’ve given 15 years of service with an employer. Pay attention to the contribution limits and your employer’s plan so you can take advantage of what’s available to you.
When Can You Withdraw Money from Your 403(b)?
Because your 403(b) is a retirement plan, you can’t just take money out when you want — at least not without paying a penalty. If you withdraw money before reaching age 59 ½, you’ll have to pay taxes and the IRS will charge you an extra 10 percent penalty. The only exception is if you have a Roth account. At that point, as long as the account is at least five years old, you can withdraw your contributions without penalty.
Be aware, too, that when you reach age 70 ½, you’ll have to start taking Required Minimum Distributions (RMDs) from your non-Roth 403(b). The government uses a formula to determine how much you should be taking each year in RMDs, and you’ll have to pay taxes on the amount, as with any other tax-deferred retirement plan withdrawal.
As you approach retirement and begin trying to figure out how much money to withdraw, and which accounts to start with, consult with a retirement professional. A knowledgeable professional can help you manage your different accounts, as well as figure out how withdrawals interact with Social Security benefits.
What Happens if You Leave Your Job?
You might have a vesting requirement with your 403(b). Vesting requires you to be with an employer for a set amount of time before you get to keep all the money from the match. The money you contribute on your own, however, is not subject to vesting.
In some cases, you might be able to keep your money in the 403(b) account, even after you leave. However, you can’t make new contributions. As a result, it might make sense to roll your money into an IRA. That will allow you to keep growing the account, and control where the money is invested.
How Much Should You Contribute to Your 403(b) Plan?
Putting money into an employer-sponsored retirement plan is one of the easiest ways to save. It comes out of your paycheck so you don’t have to think about it. However, you might be concerned about how much you can afford to divert from other goals.
A good place to start is to maximize your employer match. If your employer will match your contributions up to 3 percent of your income, consider saving 3 percent of your income. That way, you at least get some additional free money going toward your financial future.
If your employer doesn’t offer matching contributions, your 403(b) is not required to meet the burdensome oversight rules of the Employee Retirement Income Security Act (ERISA). This means you could have lower administrative fees may than you would with 401(k)s or other funds that are subject to greater oversight.
Factors to Consider
Next, you do need to consider different factors related to your current situation. Some things to keep in mind and you determine how much to put into your 403(b) include:
- Debt: High-interest debt can weigh you down. It’s ok to save a little less for retirement in the name of paying down debt faster. You can work toward both goals, but just know where the bulk of your focus should be, based on your goals.
- Emergency fund: Once you have a baseline established for retirement saving, you might want to focus on another goal. Consider building at least three to six months’ worth of expenses in an emergency fund.
- Other savings goals: Maybe you have goals like buying a home or starting a college fund. You don’t want to put your own retirement at risk to pay for your child’s college, though. Think about what you want your money to accomplish, and then go from there.
Once your goals are met, go back to the 403(b) and considerably boost your retirement savings. In fact, it’s a good idea to boost your retirement savings each time your finances improve or you get a raise.
Are There Other Ways to Prepare for Retirement?
A 403(b) is not the only way for you to save for retirement. In fact, it’s important that you consider retirement planning holistically, working it into your other short-term and long-term money goals.
In addition to using a 403(b), you can also open an IRA to set aside money in an account that you have more control over. If you qualify, you might also be able to use a Health Savings Account to begin saving up for healthcare costs in retirement.
Don’t forget that you might have other accounts from previous jobs. Rolling them all into one IRA can help you consolidate the money so that you can more effectively plan for the future. Make sure you consider taxable investment accounts, savings accounts, pensions, and even Social Security benefits in your planning.
For the most part, though, the first step is getting in the habit of saving money. You might not feel like you have “enough” money to invest for retirement. This isn’t true. Even if you only set aside 1 percent of your income, it’s still better than nothing.
Here are some tips for managing your retirement portfolio:
- Work toward increasing your contribution a little bit each year
- Review your accounts once a year and rebalance as needed
- Consolidate accounts to reduce fees and improve management
- Be realistic about your retirement needs and plan accordingly
- Incorporate other financial goals and prioritize retirement
- Use windfalls, bonuses, and other unexpected income sources to pad your account
The earlier you start saving for retirement, the less you have to contribute each month to meet your goals. However, it’s better to start late than never. Put as much as you can into your 403(b) from the get-go, taking special advantage of any employer match. As you develop the habit of setting goals and saving for them, you’ll position yourself for financial success.
Your future self will thank you.