403(b)
The 403(b) plan or Tax Sheltered Annuity (TSA), is a U.S tax-advantaged retirement savings plan
available for public education organizations, some non-profit employers, cooperative hospital
service organizations, and self-employed ministers in the United States. It has tax treatment
similar to a 401(k) plan.
Employees complete a Salary Reduction Agreement (SRA) to authorize their employer to
contribute a certain dollar amount or percentage of their pay into their account. The employer
deducts the money from the employee paycheck and it is forwarded directly to an insurance
company or custodian, who is approved for that employer’s plan. (These are the accounts we set
up) Contributions into a 403(b) plan are made before income tax is paid and allowed to grow
tax-deferred until the money is taxed as income when withdrawn from the plan. If funds are
withdrawn before age 59.5, there is a 10% tax penalty levied by the IRS.
EXAMPLE:
Say you have a client that wants to contribute $250 per paycheck into their 403(b). If their gross
income is $6,250 per pay period on a 10 month schedule, the annual salary is $62,500. Over
those 10 months the 403(b) contributions are $2,500. These contributions will reduce the
employee’s federal and state tax obligation by that amount. In other words, they will only show
a gross income of $60,000.
The $2,500 was sheltered from taxation and will continue to grow tax-deferred until withdrawn.
A major advantage of this pre-tax strategy is that the money that would have been owed and
paid in taxes is now earning interest. If we assume a total tax rate of 30%, this $2,500
contribution only affected the client’s net pay by $1,750. The other $750 would have been paid
to taxes and would not be in their retirement account earning interest.
Beginning in 2006, 403(b) plans may also include designated Roth contributions, i.e., after-tax
contributions, which will allow tax-free withdrawals if certain requirements are met. Primarily, the
designated Roth contributions have to be in the plan for at least five taxable years.
The 2017 403(b) plan contribution limits are as follows:
Plan Participants age 49 and younger, $18,000 per calendar year beginning Jan. 1st.
Plan Participants age 50 and older, $24,000 per calendar year beginning Jan. 1st.
Summary:
Employer sponsored plan
Contributions must be made through payroll
Accounts grow tax-deferred until withdrawn from the plan
Taxed as income when withdrawn (Excluding Roth)
Resources:
403bcompare.com