The 403b is a tax deferred retirement plan available to employees of educational institutions and certain non-profit organizations. Participants contribute to either annuity contracts with insurance companies, or to mutual funds with mutual fund companies. Contributions and investment earnings grow tax deferred until withdrawal (assumed to be retirement), at which time they are taxed as ordinary income. Withdrawals before age 59 ½ are subject to an additional 10% federal income tax penalty. The 403(b) was established in 1958 by the federal government to encourage employees in certain tax-exempt organizations to establish retirement savings programs. The name refers to the relevant section in the Internal Revenue Code. For exact Internal Revenue Service wording refer to IRS Publication 571. You can obtain this document by calling 1-800-829-3676 or by clicking here.
Why Contribute to a 403(b)?
- Supplement Retirement Income – Most employees of educational institutions and other non-profit organizations are provided with a pension upon retirement. Few pension plans, however, provide an amount equal to salary. A 403(b) plan can provide a supplement to help close that gap.
- Lower Taxes – 403(b) contributions are made on a pre-tax basis which can greatly reduce your tax bill. Generally, if you contribute $100 a month to a 403b plan, you’ve reduced your Federal income taxes by roughly $28 (assuming you are in the 28% tax bracket). In effect, your $100 contribution costs you only $72. The tax savings are magnified as your 403b contribution increases.
- More Tax Savings – all dividends, interest and capital gains accumulate in a 403b account on a tax-deferred basis. This means your earnings will grow without taxes until time of withdrawal when they are taxed as ordinary income. Withdrawals before age 59 ½ are subject to a 10% federal income tax penalty.