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How to Shape Your Retirement and Contribute to a 403(b)

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Feb. 1 2022, Published 4:36 p.m. ET

If you plan to contribute to your retirement, depending on the company you work for, you might be eligible to invest in a 403(b) retirement savings plan. How much should you contribute to a 403(b) if you decide to invest in one?

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A 403(b) plan is a “tax-sheltered annuity plan.” The 403(b) is available to employees who work for public schools, state colleges or universities, employees of code section 501(1)(3), tax-exempt organizations, and certain ministries. This includes qualified employees of churches, employees of public school systems that are run by Indian tribal governments, and self-employed ministers who are employed by organizations that aren’t Code Section 501(c)(3) and work as ministers daily.

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There are four 403(b) contribution options.

There are four types of contributions that can be made to a 403(b): elective deferrals, nonelective employer contributions, after-tax contributions, and designated Roth contributions. Elective deferrals allow for contributions to be made under a salary reductions agreement. The agreement permits the employer to withhold a portion of the employee’s salary and then deposit it into their 403(b).

Nonelective employer contributions are made in a salary reduction agreement. It includes matching contributions and discretionary contributions made by the employer. After-tax contributions are made by the employee and are documented as compensation for the year it was contributed. After-tax contributions are also included in the employee's gross income for tax reasons.

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Individuals seeking a 403(b) can also contribute using designated Roth contributions. Designated Roth contributions are elective deferrals that the employee plans to take into account in their gross income. Separate documentation for all contributions, including gains and losses in the designated Roth account, is required.

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There are several differences between a 403(b) and a 401(k).

A 403(b) retirement savings plan:

  • Is for non-profit and specific government entities

  • Isn't required to adhere to the Employee Retirement Income Security Act

  • Allows for catch-up contributions between $3,000 and $15,000 for employees at their job for at least 15 years

  • Is issued by insurance companies offering annuities as retirement

  • Has small vesting periods, or lacks vesting periods at all

In contrast, a 401(k):

  • Is for private-sector employees

  • Follows the Employee Retirement Income Security Act

  • Doesn't provide catch-up periods

  • Is administered by financial service firms with more investment options

  • Has longer vesting periods

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How much should you contribute to a 403(b) and are there withdrawal rules?

In general, when planning for retirement, regardless of what plan you're contributing to, experts encourage people to save at least 15 percent of their income for their retirement every year. However, when investing in a 403(b), employees might want to consider investing up to the full amount their employer matches. Note that there's a contribution limit for a 403(b) and it fluctuates every year.

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According to the IRS, for 2022, the maximum combined contribution from the employer and employee is either $61,000 or the employee’s includible compensation for his or her most recent year of service, depending on which is lesser. In 2021, the maximum was $58,000, preceded by $57,000 for 2020. Yearly contribution limits are subject to increases for annual costs of living. The employee will only pay taxes on the contributions when money is withdrawn. However, withdrawals that are made before the person reaches 59.5 years old are subject to a penalty of 10 percent along with general taxes on the withdrawn money.

Some exemptions can allow early withdrawal fees to be forgone like the rule of 55, SEPPs (substantially equal periodic payments), and medical emergencies.

The Rule of 55 notes that if a person 55 or older leaves their employer, they can make a withdrawal without penalty. SEPPs permit early withdrawals if the employee agrees to a payment schedule. If an employee has medical expenses (unreimbursed) greater than 7.5 percent of their adjusted gross income, early withdrawal without the penalty is allowed.

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