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What is a 403(b)?
Is 403b pretax or post tax is a question many people planning for retirement are asking. A 403(b) is one type of qualified plan offered to public sector employees. This tax-advantaged retirement savings account offers both investment choices and matching employer contributions. You must work full-time or part-time for a government agency to participate in a 403(b).
Before 2006, contributions were designated pre-tax, which allowed taxpayers to defer taxes until the funds were withdrawn in retirement. In 2006, Congress amended the Internal Revenue Code to require the IRS to treat such plans like traditional IRAs, requiring all contributions to be treated as taxable income upon withdrawal.
As a result, many employers shifted their contributions into 401(k)-type accounts, which allowed participants to withdraw pretax earnings without incurring federal taxation.
Today, there are three basic types of 403(b) plans offered:
• Traditional – Employer contributions are made on a pre-tax or partially pre-tax basis, and withdrawals are taxed as ordinary income.
• Deferred Compressed – Employer contributions are fully deductible, and withdrawals are taxed at the lower long-term capital gains rate.
• Roth – Employer contributions are completely deductible, and withdrawals are untaxed.
Whether you are a new enrollee in the 403(b), or a current participant, it is important to know each option. Here is a brief overview of each type of plan.
How a 403(b) Works
A 403(b), short for Section 403(b) Employee Retirement Income Security Act Plan, is a tax-advantaged retirement savings program. Employers set up these plans for employees who work for them. Employees invest money into the plan, and the employer matches part of that contribution. This allows you to put away some money without worrying about taxes.
The IRS defines a 403(b) as “a deferred compensation plan under section 457 of the Internal Revenue Code.”
Contributions to a 403(b) are tax deductible. You don’t have to pay taxes on your earnings while investing in the plan. However, there are penalties for early withdrawals.
You can withdraw funds from a 403(b) account anytime, but you’ll owe income taxes on those earnings. If you do make withdrawals, you’ll lose the benefit of the employer’s matching contributions.
There are many types of 403(b) plans. Some allow participants to select from several investment options; others require participants to invest in a specific fund or type. Your employer determines how much of your contribution goes toward matching and how much goes toward your investment.
403(B) Plan participant Eligibility
Eligible employees of Code Section 501(c)(3) tax-exempt organizations;
Employees of public schools who meet certain criteria. An educational institution is defined in Code section 170(b)(1) (A)(ii) as one that normally maintains a regular staff and curriculum and usually has a regularly enrolling body of pupils or students attending the location where its educational activities are carried out. These include teachers, administrators, and support staff at public schools, state colleges, and universities.
Eligible employees of churches
Employees of public schools organized by Native American tribal governments
Ministers employed by Code Section 501(c)(3) organizations
Self-employed ministers are treated as employed by a tax-exempt organization that is a qualified employer; and
Chaplins who meet these two criteria are employed by non-501(c)(3)s and serve as chaplains in their day-to-day professional roles at their workplaces.
How 403(b) Plans Are Taxed?
With a 403(b), you can take pre-tax dollars from your paycheck before they get taxed. Pretax contributions are considered deductible expenses because they lower taxable income. For example, someone earns $3,000 monthly and falls under a 15% federal personal exemption. They’d owe $450 in federal taxes. However, if they contribute $500 to their company’s 403(b), the IRS calculates the contribution at $2,500. So, the person would end up paying $375 in federal taxes.
If you use these formulas, you’ll see that the 403(b) plan participant contributes significantly to his/her retirement savings but incurs a large penalty when withdrawing from the account. On the other hand, if you contribute to a Roth IRA, you won’t incur any penalties when making withdrawals.
Withdrawing from an IRA before age 59½ may be subject to income taxes. If you withdraw funds before age 59½, you’ll owe taxes on them. You’ll owe taxes on these amounts at whatever tax rates you’re currently paying.
Another benefit of 403(b) employer plans is that investment gains are not taxed until withdrawn from the account. Withdrawals from traditional 401(k)s are taxed at ordinary income rates, but withdrawals from Roth IRAs are not taxed.
Contributions
403(B) Contribution Amounts?
The limit on elective salary deferrals – the most an employee can contribute to a 403(b) account out of salary – is $20,500 in 2022 ($19,500 in 2020 and 2021). Employees aged 50 or over at the end of the calendar year can also make catch-up contributions of $6,500 in 2022, 2020, and 2021 ($6,000 in 2015 – 2019) beyond the basic limit on elective deferrals.
When Must the Plan Sponsor Send Elective Deferrals?
If you’re required by law to pay out an employee’s deferred compensation within 15 business days after the payment date, you must send them their share of the payment within that time frame. Even if an employer doesn’t pay health insurance premiums during the plan year, they must provide coverage at least through December 31st.
It doesn’t make any difference whether the customer makes the payment directly to the seller or indirectly through another party (such as an intermediary). An ERISA-regulated 403(b) plan must follow the same rules as any other retirement account.
There are exceptions to this rule, but they’re rare. A 403(b) plan administrator must send elective materials to the vendor within 15 calendar days after receiving the contribution. If the plan sponsor gets its contribution checks on January 31, it has until February 14 to pay the elective deferrals.
If the employer receives contributions for the benefit year on April 30th (the first day of the calendar year), it must pay out the benefits by May 31 st. These deadlines don’t apply to retirement accounts exempt from ERISA under section 401(a)(3) of the Internal Revenue Code.
Does an Employer Have to Contribute to a 403(B) Plan?
Employers who offer 403(b) plans must contribute money to the plan. But does this mean that employers have to pay taxes on the contributions?
Contributions to a 403(b) plan are taxable income for both the employer and employee. So while the employer pays taxes on the contribution, the employee receives a tax break on his or her share of the contribution.
This means that if you’re contributing to a 403(b), you could end up paying less in taxes than if you were contributing to another type of retirement account.
But just because you’re saving for retirement doesn’t mean that you shouldn’t consider other benefits that might be available. And since private companies offer 403(b)s, you may be able to negotiate additional perks like matching funds or profit sharing.
Loans and Distributions
Employees can borrow against their 403(b) accounts if they meet certain requirements. A 403(b) plan allows for loans but is not required. An employee may borrow to the extent permitted by the company’s benefit plans.
If anyone takes a 401k plan contribution and doesn’t meet the contribution limits, or if they don’t pay back their contributions, find out how to fix this problem.
Do a 403(B) Account Offer Hardship Distributions?
A 403(b) plan allows participants to receive hardship distributions. These distributions are intended to provide additional funds during periods of financial difficulty.
The plan administrator must approve hardship distributions. Participants seeking hardship distributions must submit certain documents to ensure that distributions comply with the rules governing hardship distributions.
In addition to submitting the appropriate forms, participants must obtain a written statement from a third party confirming that they are experiencing financial distress.
This statement must include the amount of money needed to pay basic living expenses, the source of the funds used to purchase those necessities, and the expected duration of the participant’s financial difficulties.
Participants may request hardship distributions up to three times per calendar year. However, once a hardship distribution is granted, it cannot be rescinded without the approval of the plan fiduciary.
When Are 403(B) Withdrawals Allowed?
A 403(b) plan allows employees to withdraw funds from their retirement accounts for certain purposes, which include:
Reaching age 59½
Have a severance from employment
Become disabled
Pass away
Financial hardship
Employees may also be eligible for a reserve distribution. You can roll over eligible distribution amounts into another plan or IRA.
Employees who receive distributions from their employer’s retirement plan must include them in gross taxable wages for federal purposes. If no exception applies, they may also be subject to an additional ten-percent early withdrawal penalty.
How Are Benefits Paid?
403(b) plans allow employers to offer retirement savings options to their employees. These plans are offered under Section 457 of the Internal Revenue Code. Employees contribute money to the plan, and the employer matches up to 3% of each contribution. This allows employees to save for retirement without having to worry about taxes.
In addition to offering employees 401(k) plans, many companies offer a 403(b) option. Employers are required to offer both types of plans, but some differences exist. Some 403(b) plans pay out benefits in lump sums, while others use a defined benefit formula. In addition, some 403(b) plans allow participants to select how benefits are distributed.
What Happens When a 403(B) Plan is Terminated?
A terminating 403(b) distribution must be made as soon as administratively practicable. Under Revenue Ruling 2011-7, if an employer terminates a 403(b) funded retirement plan before its distribution period ends, then any amounts distributed during the termination period are not subject to tax. A 403(b) fund established under section 403(b)(7) of the Internal Revenue Code (Code), 26 U.S.C. §403(b)(7), must follow certain procedures when terminating its operations.
Is 403b Pretax Summary
In conclusion, if you have a 403(b) plan through your employer, you may be able to take advantage of pretax contributions to reduce your taxable income. However, before you decide to contribute pretax dollars to your 403(b), you should consider the following factors:
1) How much money will you save in taxes?
2) Will you still qualify for any tax breaks?
3) What happens if you leave your job?
4) Is your current employer offering a matching contribution program?