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403B Plans

403B Plans
A 403B plan is a defined contribution retirement plan primarily for employees of public school systems and tax-exempt charitable, religious, educational and scientific organizations.

Contributions to a 403B plan may be invested in annuities and mutual funds. Originally, 403B plans invested only in tax-sheltered annuities (TSA's). Even though investments may include mutual funds now, oftentimes a 403B plan is still called a TSA.

Contributions are generally made with pre-tax money. The earnings and contributions are tax-deferred while they are in the plan. In several respects, 403B plans are similar to 401K plans.

The general tax rules described below are the federal income tax rules as of January 1, 2007) and may be subject to exceptions. Always check your state (and local) income tax rules on 403B plans. Finally, since tax laws may (and probably will)change from time to time, always check with your tax advisor before making major decisions regarding your 403B plans.

Employees of qualifying organizations may participate.

Contribution Limits
There's the general rule, a special rule and alternative rules. There are IRS regulations that go into great detail about this subject. It's a good idea to contact your employer or plan provider for details for your particular plan.

The General Rule
Basically, you can contribute:

1. $17,500 in the year 2013
The maximum amount of all contributions from you and your employer cannot exceed the lesser of:
1. 25% of compensation or
2. $51,000
The special rule for long-term employees Employees who have at least 15 years of service with educational organizations, churches, hospitals and certain other health and welfare-related organizations may be able to make a larger contribution of $5,500 per year (up to a lifetime limit of $15,000). There are various qualification rules and limitations on this extra contribution benefit.

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Alternative Rules
Employees of certain organizations (e.g., schools, churches, hospitals and some other health and welfare related entities) may use one of three alternative contribution methods to make larger contributions. Once an election is made to use one of these other methods, you cannot change your mind.

Benefits of 403B Plans
1. General rule for employee contributions is that they can be up to lesser of:
a.$17,500 in the year 2013 or
b.the exclusion allowance. There are alternative rules and a special rule, too. Employee and employer matching contributions can be up to the lesser of 25% of compensation or $51,000.
2. Contributions aren't considered part of an employee's salary for income tax purposes.
3. Earnings and contributions grow tax-deferred without any reduction for income tax each year.
4. Employee contributions and earnings are 100% vested.
5. You may be able to borrow from the plan.
6. You may delay the start of distributions beyond age 70 if you continue to work.
7. Special creditor protection may be available.
Negatives of 403B Plans
1. Distributions of earnings and contributions are taxed at ordinary income tax rates (from 15% to 39.6% for federal tax plus state tax as of January 1, 2007). However, distributions of employee after-tax contributions are income tax free.
2. There is a penalty for early withdrawal unless an exception applies (see section on exceptions to early withdrawal penalty).
3. Employer matching contributions and earnings may be subject to a vesting requirement.
Your contributions and the related earnings are 100% vested with a 403(b) plan. The only exception is if you fail to pay future premiums on an annuity contract. Employer contributions and related earnings may be subject to a vesting requirement of up to 7 years for 100% vesting.

Timing of Distributions
Distributions may also be made when you:
1. separate from your employer's service (when you no longer work there) or
2. die and depending upon how your 403(b) plan is written, also when you
3. are age 59 or
4. become disabled or
5. need a financial hardship distribution.
You must start taking distributions by April 1 of the year after you reach age 70. However, if you want to delay distributions until you stop working after age 70, you can wait until April 1 of the year following retirement (there's another special rule requiring distributions by age 75 in some cases).

Income Taxes & Penalties
Distributions of earnings and contributions are usually subject to federal and state ordinary income tax (the federal rate is from 15% to 39.6%, as of January 1, 2007).

In some cases, plans also allow after-tax contributions. As to those contributions, they are returned to you income tax free since you've already paid tax on them. However, the earnings they generate are subject to ordinary income tax.

Penalties can apply in these cases:
1. Withdrawing too little once you reach age 70 can result in a 50% penalty.
2. Taking a distribution before you are age 59 is subject to a 10% penalty unless an exception applies (see exceptions to the early distribution penalty below).
Exceptions to the Early Distribution Penalty
Distributions of contributions or earnings before age 59 will also be subject to a 10% penalty unless:
1. You separated from service (are no longer working for your employer) and the separation occurred on or after the calendar year in which you reached age 55 or
2. You are disabled or
3. Your beneficiaries (or your estate) are receiving distributions due to your death or
4. You are taking the distributions under an approved annuity formula or
5. You are paying medical expenses in excess of 7.5% of your adjusted gross income or
6. You make a qualifying rollover/transfer.
Beneficiary Designations
Legal and tax advice is useful when determining how to complete beneficiary designations. Properly completed designations can help save estate (death) tax, avoid probate, allow better income tax opportunities and avoid creditor claims on retirement assets.

Extra care needs to be taken in naming trusts as a beneficiary of most retirement assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger income tax sooner than it would otherwise be owed and reduce the amount ultimately shielded from death tax.

Note that many plans require the participant's spouse to be the beneficiary, unless the spouse provides written permission for another beneficieary to be named.

Creditor Protection
Retirement plans and accounts may have special creditor protection under federal and/or state laws. Different types of plans and accounts may have varying degrees of protection. State protection rules may also vary from state to state.

If you convert from one type of plan to another (e.g., from a traditional IRA to a Roth IRA), you may be changing how much protection you have. This may be also be the case if you move to another new state where the new state rules are different.

Consulting with an attorney for guidance on the creditor protection issue may be helpful.

Estate and Death Taxes
Retirement assets are added to your other assets and may be subject to federal and/or state death (estate) tax. It depends upon the size of your overall estate and the estate planning done for you. Consult with your advisor about ways to defer or avoid estate tax.

For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.

This page (formatted for versions 10.0 and higher of Internet Explorer) is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to see a specific wealth management topic in the left margin of each page.

Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

The information contained in this web site is neither an offer nor solicitation of any security or service.


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