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.
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
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.
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:
Negatives of 403B Plans
a.$17,500 in the year 2013 or
2. Contributions aren't considered part of an employee's salary for income tax purposes.
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
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 70½ if you continue to work.
7. Special creditor protection may be available.
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
You must start taking distributions by April 1 of the year after you reach age 70½. However, if you want to delay distributions until you stop working after age 70½, you can wait
until April 1 of the year following retirement (there's another special rule requiring distributions by age 75 in some cases).
2. die and depending upon how your 403(b) plan is written, also when you
3. are age 59½ or
4. become disabled or
5. need a financial hardship distribution.
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 70½ can result in a 50% penalty.
Exceptions to the Early Distribution Penalty
2. Taking a distribution before you are age 59½ is subject to a 10% penalty unless an exception applies (see exceptions to the early distribution penalty below).
Distributions of contributions or earnings before age 59½ 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
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.
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.
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:
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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.
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