Named for the Tax Code (403(b)) governing these type of Tax Shelter Accounts are used by people who work for not for profit organizations, certain employees of religious institutions and employees of public schools alike. While originally called Tax Shelter Annuities (TSA), that term has not been accurate since 1974 when the U.S. Government changed the laws governing these plans to allow for more investment choices rather than just annuity products offered by insurance companies.
These are plans are established by the employer and typically voluntarily funded by the employee as a way of supplementing their retirement savings. The maximum contribution in 2018 is $18,500 ($18,000 2015-2017) and is indexed to inflation. The employees who wish to participate in the plan will have a predetermined amount of their pay withheld by the employer by completing a Salary Reduction Agreement. The Salary Reduction Agreement will specify the amount, frequency and the company the funds are to go to. The employer will typically have a group of annuity or investment options the employee may send the contribution to and the employee is free to choose among the options, this is often referred to as “The Approved List”. The Third Party Administrator will administer the plan, direct the funds to the employee’s plan of choice and will handle all transfers into and out of the plan. As the contributions are done on a pre-tax basis, the contributions are not taxed as income. The account grows tax-deferred, based on the investment choice, and will be taxed as ordinary income when they are withdrawn.
The contribution limits on 403(b) are higher than many other plans and while most of the plans are funded only by the employee, there are plans where the employer makes some or all of the contribution. They also allow employees who are over age 50 to add additional dollars into the plan if they wish to “catch up” on retirement savings to further grow their assets. Some 403(b) plans offer additional benefits: such as allowing the participant to borrow funds out of the plan and access for early retirement, education or home purchases.
Some employers offer the Roth 403(b) with many of the benefits of the Roth IRA. There are some important differences from both Roth IRA and traditional 403(b). First, if the Roth 403(b) election is made, the contributions to the plan are not tax deductible as with a traditional 403(b) plan; but they will be accessible income tax-free at retirement, similar to the Roth IRA. Unlike the Roth IRA, which has certain early access provisions, the Roth 403(b) does not and you must wait until age 59 1/2 or later to access the funds.
To qualify for the tax-free penalty-free withdrawal of earnings, a Roth 403(b) must be in place for at least five tax years, and the distribution must take place after 59 1/2 or due to death or disability. Before taking any specific action, be sure to consult with your tax professional.
If you would like to know more about your current 403(b) plan or how 403(b)/TSA plans can play a role in your personal financial strategy, contact a Trilogy adviser.