Investment Glossary – 403(b)
Much like the vaunted and highly publicized 401(k) plan, a 403(b) plan is a savings vehicle that employers offer to their employees so they can save for retirement in a tax-deferred fashion. The key difference is that invested of a for-profit employer offering the plan, 403(b) plans are offered by schools, nonprofits, and religious organizations. It’s effectively a 401(k) plan that works with their unique tax status. But other than that, it’s pretty similar.
Contribution limits for 403(b) plans are the same as 401(k) plans, with those limits rising from $19,000 in 2019 to $19,500 per year in 2020. There is also the same $6,000 catch-up contribution afforded to employees age 50 or older, so you can save a little more into your retirement account as you get older. There is also the same provision for employer matching contributions, so just as you can get a 401(k) match at a for-profit company, there are 403(b) matches at nonprofits, schools, and religious organizations. Like the 401(k) plan setup, the maximum combined employee and employer contribution in a given year is $57,000 as of 2020. And every single sentence in this paragraph showed that 403(b) plans, from the perspective of the employee, are effectively identical to 401(k) plans. That’s by design, so that nonprofit workers are not disadvantaged in terms of their ability to save for retirement compared to for-profit workers.
As far as investment choices, most 403(b) plans utilize mutual funds, though some offer annuities as well. Investment costs have come down in recent years, as there has been a focus on reducing fees, with greater competition in this area over the last couple of decades. Most plans offer a variety of different investment options (usually between 10 and 20) and they also typically have varying levels of risk. So if you want to take on additional risk and load up on equities, you can do that. On the flip side, if you would rather not take on as much market risk, you can back off and focus more on bonds and other fixed income investments instead. Investment choice is typically left up to the employee, though a number of plans offer some form of consultation with a financial advisor or associated person who may be able to help you in selecting an investment allocation based on your needs and risk tolerance.
403(b) plans also have the same 10% early withdrawal penalty if you pull funds out prior to age 59.5 without a reason that would qualify for a waiver. So if you are planning on needing access to these funds to buy a car when you’re 45 or to pay for a wedding when you’re 55, a 403(b) isn’t the best savings vehicle for those uses because of the extra tax you’d end up paying because of early withdrawals. But the high contribution limits and wide variety of available investment options make 403(b) plans really popular, and you see that at most schools and nonprofits.