403b plan

What is a 403b plan

A 403b plan is a retirement account available to individuals working for non-profit organizations, certain government entities, certain 501(c) (3) organizations (tax-exempt), and ministers.

Employers eligible to offer the 403b plan are:

• Public schools, colleges or universities,
• churches, or
• Charitable tax-exempt entities under Section 501(c)(3) of the IRC

Is a 403b tax deferred

All gains in funds contributed to a regular 403b plan are tax-deferred until withdrawal.

Gains on amounts in a Roth 403b are tax-deferred for qualified distributions withdrawals.

Differences between 401k and 403b

403b is similar to a 401k in many ways, but with a few major differences including;

Employer type

401k plan is tailored for private-sector employers while the 403b plan is mainly for non-profit and certain government entities.

ERISA exemptions

Unlike private companies offering 401ks, entities offering 403b plans are exempt from certain ERISA rules. Some 403b plans may get away with non-discrimination requirements and may confer some employees’ preferential treatment. Notably, ERISA exemptions typically bar this entity from making employer contributions to 403b plans.

Enhanced contributions

The catchup contributions for 403b employees is $3,000 per year (up to a lifetime limit of $15,000) for employees who’ve been with the same employers for at least 15 years.

IRS ties this catchup to the length of service as opposed to age.

Plan administration

403b plans are typically administered by insurance companies, which often specialize in annuities as retirement investments (Not suitable for younger employees). 401k, in contrast, is usually administered by financial services firms offering a bigger range of investment choices.

Shorter vesting periods

Most 403b plans employer matching contributions either vests immediately or have relatively short vesting periods.

403b vs. 401k comparison chart   

Is 403b a traditional IRA

Broadly speaking, a 403b plan is divided into two types;

• The Traditional type and
• The Roth type.

Some employers restrict access to the Roth version.

A traditional 403b plan allows the employee to contribute pretax money directly at the payroll level into their retirement account. The taxes on contributions are due on the withdrawal of funds from the retirement account.

A Roth 403b is funded by after-tax money hence funds will not accrue any more taxes when withdrawn.

401k rollover to 403b

Transferring 401k to 403b

IRS doesn’t allow companies to offer both a 401k and 403b plan to their employees. This is so because 401k plans are mainly for for-profit employers, while 403b plans are for non-profits.

However, should you switch employment from a for-profit company to a non-profit, you might consider taking your retirement savings across. IRS allows the movement of funds from a 401k plan into a 403b plan. This allowed through;

• A rollover or
• A direct transfer.

With a rollover, funds are first paid to you, and then you redeposit into the new 403 plan. The redeposit should happen within 60 days.

Direct transfer automatically moves funds from your 401k plan to your 403b plan. This is the preferred option unless you need to use the funds for up to 60 days.

How much can you contribute to a 403b

Max contribution to 403b

403b contributions for 2022

403b plan accounts are the same as 401k contribution limits but much higher than IRS Contribution Limits.

IRS caps this at;

• $20,500 for tax year 2022 ($19,500 in 2021) if you are below age 50, or
• $27,000 yearly for the tax year 2022 if you are above 50 years ($26,000 in 2021).

Note that should the employer offers access to both a 401k and a 403b plan within the same year, the limit is determined by total contributions to both accounts.

You are eligible to contribute up to $3,000 in catch-ups in a given year if you have been employed for at least 15 years within the same eligible entity (up to $ 15,000-lifetime maximum). Please also take note that this enhanced catchup is not a replacement for the federal catch-up contribution for over 50-year-olds, hypothetically you can contribute $30,000 per year for five years.

Lastly, combined employee/employer contributions are capped at $61,000 or 100% of the most recent yearly salary, whichever is less.

Annual 403b contribution limit 2021

For the tax year, 2021 IRS capped the Maximum allowable contributions for employees to a 403b retirement at;

• $19,500 for tax year 2021 ($19,500 in 2020) if you are below age 50, or
• $26,000 yearly for the tax year 2021 if you are above 50 years ($26,000 in 2020).

What is the maximum 403b contribution for 2020

For the tax year 2020, IRS capped the annual deferral limit for 403b to;

• $19,500 for tax year 2020 ($19,000 in 2019) if you are below age 50, or
• $26,000 yearly for the tax year 2020 if you are above 50 years ($25,500 in 2019).

403b maximum contribution 2019

 IRS capped the annual deferral limit for 403b for 2019 to:

• $19,000 for the tax year 2019($18,500 in 2018) if you are below age 50, or
• $25,500 yearly for the tax year 2019 if you are above 50 years ($24,500 in 2018).

403b limits for 2018

This capped at;

• $18,500 for the tax year 2018($18,000 in 2017) if you are below age 50, or
• $24,500 yearly for the tax year 2018 if you are above 50 years ($24,000 in 2017).

403b employer contribution limits

Employers sponsoring a 403b plan may match some employees’ own contributions. Each entity has its own rules on how, when, and if it should match employee contributions.

Employer limits on contribution are a bit complicated. Employers may contribute on behalf of employees’ 403b plans up to;

• total employee/employer contributions maxed at either $55,000 or
• 100% of all taxable wages and benefits for employees’ most recent tax year, whichever is lower

What happens if I overcontribute to my 403b

The contributor should notify the plan administrator of any Excess Deferrals made during the year. This avoids double taxation.

It is advisable to remove the excess funds before April 15^th. IRS taxes Earnings on any excess deferrals in the year of distribution.

A 6% excise tax per year will be levied until the excess is absorbed or corrected (The tax cannot be more than 6% of the combined value of all IRAs at tax year-end).

If you are under 59 ½, late distributions will be subjected to the 10% early distribution tax, a 20% income tax withholding, and subject spousal consent requirements.

When can I withdraw from 403b

Standard 403b Withdrawals

IRS taxes standard withdrawals as regular income. Withdrawals from a Roth 403b are tax-free.

Conditions for making a standard withdrawal include:

• Attaining the age of 59 ½
• Becoming disabled
• Experiencing financial hardship
• Death (Beneficiaries will take withdrawals from your account)
• Required Minimum Distributions (RMDs). At age 72, IRS mandates certain minimal withdrawals. Failure to do this leads to a tax penalty of 50% of your RMD.

Cashing out 403b early

403b early withdrawal penalties

Cashing out is never a good idea as it triggers undesirable penalties and taxes (unless an exception applies), as well as limits the potential of your investment to grow.

Withdrawals from a 403b account before age 59 ½ are subject to a 10% penalty on top of taxes on any deferred funds in the account.

403b early withdrawal exceptions

Exceptions that let you avoid early withdrawal penalties include:

The Rule of 55

If you;

• Quit your current employer and
• Aged 55 or later

IRS allows withdrawals from this employer’s 403b penalty-free. However, this is not applicable to funds in previous employer plans or IRAs.

Substantially equal periodic payments (SEPPs).

The 72(t) rule, allows the retirement saver to agree and stick to a payment schedule that avoids the 10% penalty for early withdrawals at any age, for at least five years or until age 59½ (whichever comes later)..

Qualified medical expense.

If your unreimbursed medical expenses exceed 7.5% of your adjusted gross income, you can access early withdrawal without paying the penalty.

Hardship 403b withdrawal

Hardship withdrawal lets 403b savers pull out funds off their accounts without facing the 10% early withdrawal penalty charged to individuals who have not attained the age 59½.

IRA has not mandated 403b plans to allow for a hardship withdrawal. However, a 403b plan may allow hardship distributions based on its terms.

This distribution is only accessible for;

• Immediate and heavy financial need and;
• Limited to the amount necessary to address that financial need.

A financial need is still immediate and heavy even if it was foreseeable or voluntarily incurred by the employee.

The amount distributed is deemed necessary to satisfy an immediate and heavy financial need if two conditions are met;

• The distribution is not greater than the amount needed to address the immediate and heavy financial need, including extra amounts required for payment of taxes.
• The employee cannot access any other available distributions and has Taken all available plan loans prior to a hardship withdrawal.

6 months suspension of contributions will follow after this hardship.

Rolling over 403b to Roth IRA

IRS allows a 403B to a Roth IRA roll as long ;

• You are over 59 1/2 years of age and can access your 403b penalty-free and at will, or
• You are not working for the sponsoring entity.

It’s also possible to roll Traditional 403b into a Roth IRA. However, IRS considers this a “Roth conversion,” and thus has to be reported on your returns as income and ordinary income tax accrues in this. This is so because funds have moved from a pre-tax to an after-tax retirement account.

IRS also allows a Roth 403b into a Roth IRA and is tax-free.

Administrators process this as;

• A direct rollover where distributions are payable directly to your IRA custodian.
• Payable directly to you less a tax withholding of 20%.

If funds are payable directly to you, ensure you deposit within 60 days into an IRA. This should be inclusive of the 20% withholding.

403b withdrawal for home purchase

IRS might allow access to your 403b as a deposit towards a home purchase, just don’t expect special tax treatment. However, the 10% early access penalty is not applicable as this falls under hardship access.

Contributors over 59 ½ years old are given exceptions to access as much of their 403b plan as they desire, be it for a down payment on a new house. However, income taxes still accrue on this distribution.

Contributors under 59 ½ might not be able to access 403b plan funds if still working for the same employer — unless

• The sponsor allows hardship withdrawals from the plan for mortgage down payments.
• There is no other way to pay for the down payment e.g. you can’t take a hardship distribution if you have access to loans.
• IRS allows hardship distribution if the mere loan prevents you from a mortgage.

Please note that IRS doesn’t give exceptions for distributions taken from your 403b plan for a mortgage, even if it’s for the purchase of a primary residence or even a first home. However, the only exception IRS allows, in this case, is a withdrawal of up to $10,000 (probably not enough to cover the down payment) over a lifetime without penalty for buying your first-time home. This $10,000 distribution is not subject to penalty, but income taxes apply. 

Qualification for a hardship withdrawal for a down payment of a house loan is not a waiver from early withdrawal penalties and other taxes.

You are allowed to borrow up to $50,000 or half of the vesting balance, whichever is less.

Typically, 403b loans are payable within 5 years.  IRS allows extensions if the loan is towards a home purchase.

Interest paid on the loan pay goes back into your 403b account.

Required Minimum Distribution 403b

It is not a requirement to draw from your 403b on retirement. But, this changes once you reach the golden age.

This begins on the latter of:

• Attaining the age of 72, or
• Retirement (if after the age of 72)

The following dates are key when determining when the golden age of 72;

• If attained the age of 70½ before January 1, 2020, then the RMD age is 70½, not 72.
• If you turn age 72 or retire (and you’re already age 72 or over, or were age 70½ or older on December 31, 2019)

It’s possible to delay first-year RMDs until April 1 of the subsequent year. However, you have to take second-year RMDs within the same year as well—potentially increasing your tax liability.

Ensure you take RMDs by December 31st of each year

Can you borrow from a 403b

Most 403b plans include provisions, which allow contributors temporary access to their retirement savings.

403b loans are simply getting access to your own retirement money by loaning it to yourself. These funds are traditionally off-limits before the golden age of 59 ½.

IRS caps the loan to 50% of your vested amounts or $50,000, whichever is smaller. If the account has less than $10,000, the IRS permits full access to the balance. Certain 403b plans may have even stricter limits.

Payment is in equal installments, at least once quarterly and within five years. Again, individual 403b plans may have stricter rules

What happens to 403b when you quit

Clear your loan balance in full else IRS will deem the entire loan a distribution.

IRS will consider this as income for that tax year, and if under 59 ½, a 10% early access penalty is applicable as well.

How are 403b taxed

403b offers tax-efficient growth for contributed retirement savings (free of capital gains taxes). Taxes are due on distributions on retirement.

Reporting 403b on taxes

Generally, IRS does not require you to report contributions to a 403b account on your tax return. However, Roth contributions are reportable on your tax return.

You must report every withdrawal to the IRS and pay ordinary income tax on the amount of the distribution.

With Direct 403b transfers, IRS does not require you to report this on your returns. However, if you move funds through a rollover, you should report it on your returns.

403b on tax return

Self-employed ministers must report their total contributions as a deduction on line 28 of Form 1040.

Report rollovers on either form 1040 or 1040A a nontaxable distribution. Indicate “rollover” next to this to indicate you have rolled these funds over.

Employers will report 403b contributions on your Form W-2. Show your Elective deferrals in box 12 and they check the Retirement plan box.

Bottom line

Take full advantage of your employer’s matches to your contribution. Failure to capitalize on this is equivalent to turning down free money.

You will change jobs multiple times over your career, this results in a trail of retirement accounts. Consolidating these accounts will make it easy to manage and monitor growth.