Many private sector employees are eligible to participate in their employer’s 401(k) plan, a retirement plan that includes the ability to defer federal and state income taxes on a significant portion of their income, receive a company match, borrow against the plan, and participate in a wide assortment of investment options. Ministers, employees of non-profit companies, public school employees and several other employment categories have a similar type of retirement plan in the 403(b), also known as a tax sheltered annuity (TSA) or tax deferred annuity (TDA). In fact the plan has very similar characteristics to the more popular 401(k).
Who can participate in a 403(b)?
Participation is generally limited to employees of public schools or non-profit (501(c)(3)) organizations, or ministers. Per the IRS, participants specifically include the following:
- Employees of tax-exempt organizations established under section 501(c)(3) of the Internal Revenue Code, usually referred to as section 501(c)(3) organizations or simply 501(c)(3) organizations.
- Employees of public school systems who are involved in the day-to-day operations of a school.
- Employees of cooperative hospital service organizations.
- Civilian faculty and staff of the Uniformed Services University of the Health Sciences.
- Employees of public school systems organized by Indian tribal governments.
- Ministers employed by section 501(c)(3) organizations.
- Self-employed ministers. A self-employed minister is treated as employed by a tax-exempt organization that is a qualified employer.
- Ministers (chaplains) who meet both of the following requirements: They are employed by organizations that are not section 501(c)(3) organizations, and they function as ministers in their day-to-day professional responsibilities with their employers.
403(b) Contribution limits
Generally speaking, a participant may elect to defer a maximum of $18,000 of earnings per year under a 403(b) for 2017. Just as with other retirement plans (see a comparison of contribution limits), the 403(b) includes a “catch up” provision. For participants age 50 and older, an additional $6,000 may deferred for a total of $24,000 per year. A participant in a 403(b) can defer up to 100% of his or her earned income under the plan, subject to the annual maximum contributions above.
An employer can match contributions, but the combined employee/employer contribution to the employee’s account cannot exceed $54,000. The total also includes all other plans that the employee participates in, including a Roth IRA. And speaking of Roth IRA’s, an employer can set up an employer sponsored Roth 403(b). The contribution amounts may not be exceeded if a participant has more than one eligible employer plan.
The ’15 Year Rule’
If a participant is employed by an eligible organization, which includes churches or a convention or association of churches (or associated organization), 403(b) plans have a provision for additional contributions based on years of service. If a participant has at least 15 years of service he can increase his contribution by the lower of:
- $15,000, reduced by the sum of: (a) the additional pre-tax elective deferrals made in prior years because of this rule, plus (b) the aggregate amount of designated Roth contributions permitted for prior tax years because of this rule, or
- $5,000 times the number of your years of service for the organization, minus the total elective deferrals made by your employer on your behalf for earlier years.
It’s complicated, but with the 15-year rule your contributions can be as high as $21,000 for 2016.
Like most other qualified retirement plans, if you withdraw funds from a 403(b) prior to turning 59½ you will have to pay taxes on the amount withdrawn, as well as be subject to a 10 percent early withdrawal penalty. Exceptions apply, including certain narrowly defined hardships as well as rollovers to IRA’s, other 403(b) plans, and to 457 plans (government employees). Similar to 401(k) plans, the employee can also take loans against the plan for certain purposes. As with other qualified retirement plans, minimum required distributions (MRD’s) are required beginning at age 70½.