A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan offering a wide range of tax-sheltering and tax savings opportunities for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers. These plans resemble 401(k) plans in many respects, but are specially designed for nonprofit entities. Seven of the top benefits of a 403(b) plan include the following:
Contributions Are Tax Deductible
Contributions to a traditional 403(b) plan are deductible for federal income tax purposes, reducing the amount of income tax paid at the individual's marginal tax bracket. For example, if the last $10,000 of a worker's adjusted gross income would be taxed in the 25% tax bracket, putting that $10,000 into a traditional 403(b) would net a tax savings of $2,500. In addition, "earnings apply to the entire balance instead of one reduced by taxes. This tax savings opportunity has the positive effect of increasing one’s overall returns.
Savings Grow Tax-Deferred
A huge advantage of a 403(b) plan is that you do not have to currently pay taxes on dividends, interest and capital gains on your investments held in the 403(b) account. By comparison, when holding your retirement investments in a non-tax-sheltered account, you will lose a lot of potential earnings due to the significant drag impose by taxes. Furthermore, the ongoing total maintenance of the account is enhanced inside of a 403(b) plan due to the freedom it affords for portfolio re-balancing without negative tax effects.
Contribution Limits Are Higher than for IRAs
The more money that you can save for your retirement on a tax-sheltered basis, the better off you will be. As an employee, you can put up to $18,000 into a 403(b) in 2017. Employees who are 50 or older may be eligible to make up to a $6,000 additional catch up contribution in 2017. These contribution limits are huge compared with the $5,500 limit and $1,000 catch up limits on IRAs.
Taxes May Be Deferred until Distributions in Retirement
With contributions being made with pretax contributions, distributions are taxable. The good news is, however, that when these distributions are made during retirement, most retirees are in a lower tax bracket; therefore, this means additional tax savings. Furthermore, most retirees require less income than during their peak earning years.
You Can Take Out a Loan on a 403(b)
Although it depends on the specific provisions of your 403(b) plan, most people will find they are allowed to take a loan out of their 403(b) plans. Nonetheless, the requirements for the loan are very exacting. Missing even one payment can mean that you have defaulted on the entire loan amount, triggering IRS penalties for an early withdrawal.
Employers Can Offer Matching Contributions
Another important reason to put money into a 403(b) is because your employer may offer matching contributions. If this is the case, you should be sure to contribute in order to take advantage of this free money.