What is a 403(b)?

In the financial world there seems to always be an alpha-numeric soup of letters and numbers mixed together that mean something. My goal is to read to soup mix and try to explain how readers can personally benefit.

A 403(b) is a qualified retirement plan available to employees of most public and private schools, colleges and universities, nonprofit hospitals and other tax-exempt 501(c)(3) organizations, such as charitable institutions, foundations, and religious organizations. This retirement program, allowed by the Internal Revenue Code, enables these employees to contribute pre-tax dollars for their retirement, thus reducing their current taxable income. Here’s how.

The amount you contribute to your 403(b) is not reported as taxable income on your W-2 to the Internal Revenue Service (IRS). If you contribute $333 of your monthly salary of $3,333 to a 403(b), only $3,000 is reported as taxable income to the IRS; thus your 403(b) program reduces your taxable income. What does this mean? Well in this example, assuming a 5% State and a 28% Federal tax rate, your monthly income would increase by $280 or $3,360 annually! As compare to saving the same $333 in an after-tax savings account.

Tax-deferred growth is another advantage of a 403(b). This allows your money to grow faster because you earn interest on dollars that would otherwise be taxed. Your principal earns interest, the money saved in taxes earns interest and the interest compounds. Wow! Triple compounding!
In our previous example of saving $333 a month, earning 6% annually, this triple compounding helps the fund to grow to $112,299 in 20 years and $241,349 after 30 years. Your contributions and interest earned continue to grow on a tax-deferred basis until distributions are received, usually at retirement.

A 403(b) allows higher annual contributions then a Traditional IRA. For 2009 the contribution limit to a 403(b) is $16,500 with those age 50 and over allowed to contribute an additional $5,500 for a total of $22,000. An IRA has contribution limits this year of $5,000 and those age 50 and over can contribute an additional $1,000 for a total of $6,000. Sixteen thousand dollars ($16,000) less than the over age 50 403(b) plan participate.

Some other advantages of a 403(b) is a loan provision that allows for you to borrow money from your plan without being subject to surrender charges and in most cases without tax consequences. These loans must however be repaid with after-tax dollars. Another advantage is an exemption from the age 591/2 premature withdrawal penalty. With a 403(b) the age limit is lower at age 55.

Lastly, we all want to know what happens to the money when we are spending time with the earthworms six feet under. Your beneficiaries will receive the value of your 403(b), minus the balance of any outstanding loans. This amount will generally avoid the probate process. And in most cases your beneficiaries may roll the remaining 403(b) funds over to a qualified plan in their name and avoid a taxable distribution.

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Wm. Steve Wright
Managing Member
The Wright Legacy Group, LLC
A Registered Investment Advisory Firm