By Peter Mastrantuono
A 403(b) plan, also sometimes referred to as a tax-sheltered annuity plan, is a retirement plan for employees of public schools, 501(c)(3) tax-exempt organizations and certain ministers.
There are significant tax and retirement planning advantages to a 403(b), including pre-tax contributions and tax-deferred earnings. The allowable contribution limits are the same as a 401(k) and well above IRAs. One big difference is that employees who have worked for the same employer for 15 years or more may be able to make a $3,000 contribution annually (with a lifetime maximum of $15,000) in addition to the same standard and catch-up contribution limits of a 401(k).
While a 403(b) represents an excellent retirement savings option, there are some important considerations:
- Fewer Investment Choices: 403(b) investments are generally limited to mutual funds and variable annuities. Other retirement plans, like an IRA or 401(k) may have a broader selection of investment choices, including individual stocks and ETFs.
- High Fees: Investors need to be fee aware. A number of 403(b) plans are subject to high fees, especially the tax-sheltered annuity investment option. Fees can materially reduce the amount of savings that investors are able to accumulate over the long term. The tax-sheltered annuity does provide some benefits that a mutual fund cannot offer, so you may want to sit down with your financial advisor to determine if those benefits are worth the higher fees.
- Not All 403(b) Plans are Protected by ERISA: The Employee Retirement Income Security Act (ERISA) requires some minimum standards for retirement plans (e.g., reporting and fiduciary), which serve to protect employees. Some 403(b) plans are exempt from ERISA requirements. ERISA exemption doesn’t necessarily make them “bad” plans, but it may mean that individuals need to more diligent about how the plan is managed and administered.
- Limited Access to Funds: Similar to a 401(k) or IRA, access to 403(b) savings is limited. Withdrawals prior to age 59.5 that are not due to disability, loss of employment, death or financial hardship (provided the plan permits hardship withdrawals) are subject to a 10% premature distribution tax penalty in addition to ordinary income taxes on the withdrawn amount.
- Confusing Array of Options: While 403(b) plans may offer limited investment choices, some employers (especially public schools) may permit multiple mutual fund companies and insurance providers to offer their products to employees. This can heighten complexity and lead to less optimal decisions.
Despite these drawbacks, a tax-advantaged 403(b) plan represents one of the most effective ways for you to accumulate retirement savings. Navigating your way through the multiple investment options can lead to indecision and costly procrastination. To help you clear this hurdle, consult with your financial advisor, who will be happy to review the investment choices you have and discuss building a diversified portfolio to meet your financial goals.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.