What Is a 403(b) Plan?
From irs.gov: A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
Individual accounts in a 403(b) plan can be any of the following types.
- An annuity contract, which is a contract provided through an insurance company,
- A custodial account, which is an account invested in mutual funds, or
- A retirement income account set up for church employees. Generally, retirement income accounts can invest in either annuities or mutual funds.
What Are the Benefits of Contributing to a 403(b) Plan?
There are three benefits to contributing to a 403(b) plan.
- The first benefit is that you do not pay income tax on allowable contributions until you begin making withdrawals from the plan, usually after you retire. Allowable contributions to a 403(b) plan are either excluded or deducted from your income. However, if your contributions are made to a Roth contribution program, this benefit does not apply. Instead, you pay income tax on the contributions to the plan but distributions from the plan (if certain requirements are met) are tax free.Note. Generally, employees must pay social security and Medicare tax on their contributions to a 403(b) plan, including those made under a salary reduction agreement.
- The second benefit is that earnings and gains on amounts in your 403(b) account are not taxed until you withdraw them. Earnings and gains on amounts in a Roth contribution program are not taxed if your withdrawals are qualified distributions. Otherwise, they are taxed when you withdraw them.
- The third benefit is that you may be eligible to take a credit for elective deferrals contributed to your 403(b) account.
Who Can Participate in a 403(b) Plan?
Any eligible employee can participate in a 403(b) plan.
Eligible employees. The following employees are eligible to participate in a 403(b) plan.
- Employees of tax-exempt organizations established under section 501(c)(3). These organizations are 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.
- Certain ministers (explained next).
You cannot set up your own 403(b) account. Only employers can set up 403(b) accounts.
How Can Contributions Be Made to My 403(b) Account?
Generally, only your employer can make contributions to your 403(b) account. However, some plans will allow you to make after-tax contributions (defined below).
The following types of contributions can be made to 403(b) accounts.
- Elective deferrals . These are contributions made under a salary reduction agreement. This agreement allows your employer to withhold money from your paycheck to be contributed directly into a 403(b) account for your benefit. Except for Roth contributions, you do not pay income tax on these contributions until you withdraw them from the account. If your contributions are Roth contributions, you pay taxes on your contributions but any qualified distributions from your Roth account are tax free.
- Nonelective contributions . These are employer contributions that are not made under a salary reduction agreement. Nonelective contributions include matching contributions, discretionary contributions, and mandatory contributions from your employer. You do not pay income tax on these contributions until you withdraw them from the account.
- After-tax contributions . These are contributions (that are not Roth contributions) you make with funds that you must include in income on your tax return. A salary payment on which income tax has been withheld is a source of these contributions. If your plan allows you to make after-tax contributions, they are not excluded from income and you cannot deduct them on your tax return.
- A combination of any of the three contribution types listed above.
Do I Report Contributions on My Tax Return?
Generally, you do not report contributions to your 403(b) account (except Roth contributions) on your tax return. Your employer will report contributions on your 2014 Form W-2. Elective deferrals will be shown in box 12 and the Retirement plan box will be checked in box 13. If you are a self-employed minister or chaplain, see the discussions next.
How Much Can Be Contributed to My 403(b) Account?
There are limits on the amount of contributions that can be made to your 403(b) account each year. If contributions made to your 403(b) account are more than these contribution limits, penalties may apply.
Contact me today to discuss enrollment options and plans available.
Contributions to a TDA plan are usually made on a before-tax, or pretax, basis. This means your contributions reduce your current taxable income and the taxes you currently owe. Tax example with no investment:
Currently monthly income: $4,000
Taxes owed @ 28%: $1,120
Take Home: $2,880
Let’s say you feel like you can only afford to invest $150 per month, then enroll in a tax-deferred 403b investing $200 per month. You will only feel a $144 hit to your monthly income. See example:
Currently monthly income: $4,000
Monthly investment: $200
Taxable income: $3,800
Taxes owed @ 28%: $1,064
Take Home: $2,736
Information obtained from the IRS website.