403(b) Plan Basics

With Americans living longer and spending more years in retirement, it is paramount to financially prepare for the golden years. Your employer-sponsored 403(b) provides a great opportunity to help you prepare for a brighter financial future.

What's a 403(b) plan?

A 403(b) plan, also known as a tax-sheltered annuity plan, is a retirement plan for certain employees of tax-exempt organizations. A 403(b) plan allows employees to contribute some of their salary to the plan. The employer may, but not required to, contribute to the plan for employees. Generally, public schools, Code Section 501(c)(3) tax-exempt organizations or churches can set up a 403(b) plan.

403(b) plan benefits

Compared to other savings vehicles available to nonprofit sector employees, the 403(b) plan can be advantageous in many ways. Here are our top eight reasons why you should join your plan.

Top Three: Saving Made Easy

1. It’s so easy even a cave man can do it. You choose a dollar amount or a percentage of your salary you want to save, and your employer automatically deducts your contributions every time you are paid. Your savings is then deposited into a unique account within the plan under your name. You don’t need to remind yourself to write a check.

2. You get free money with an employer match. To encourage employees to take part in their retirement plan, over 70 percent of plans offered some kind of matching. If your employer offers match, don’t pass up this freebie.

3. You get two tax breaks when you save in a 403(b) plan. First, your pre-tax contributions are tax-deductible. The money you contribute doesn’t count toward your gross income for the year, lowering your taxable income. Second, savings grow tax-free until you withdraw the money. You never pay taxes on contributions, dividends and capital gains within your 403(b) account.

Two More: Good Strategies

4. Power of compounding. By contributing to your 403(b) plan, you can harness the power of compounding by keeping your money invested for the long term and reinvesting interest, dividends, and capital gains you may earn along the way. In other words, you begin to earn interest on the interest you receive, which can multiply your money at an accelerating rate.

Let’s take an example. Take the number two and double it, then double that number, and again. After you have doubled two only 10 times you reach 2,048. Interest compounding works the same way. Assuming an eight percent average return, you can reasonably expect a one-time 401(k) savings contribution to double every seven years. If you consider most individuals have at least a 35-year working life, their initial contributions could double at least five times. If you are adding to your original contribution each year and receive an employer match, you can see your savings have some real growth potential.

5. Tax credits. Certain low-income workers may qualify for a Saver’s Credit to help offset part of the first $2,000 they contribute to a 403(b).

Final Three: Building An Account

6. Withdrawal flexibility. Loans and hardship withdrawals may let you withdraw money in an emergency. Many plans allow loans (which you pay back) or hardship withdrawals (which you don’t) as a way of getting your money out in an emergency. However, because this money is intended to be for retirement, early withdrawal comes with a big set of attached strings. It’s prudent to weight all other options first.

7. If you leave your job, you can roll over your account into your new employer’s plan (if they allow it) or into an IRA. In either case, your account stays tax deferred.

8. Social Security likely won’t be sufficient. It’s generally acknowledged that Social Security is only intended to provide a small percentage of your retirement income. Financial planners generally indicate that an individual will need between 70 percent and 90 percent of his pre-retirement income to live comfortably in the golden years. Where is that money going to come from? A 401(k) plan can be a great source.

Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.