A 403(b) plan, often referred to as a tax-sheltered annuity account (TSA), is a retirement plan offered exclusively by public schools and certain charities. A 403(b) plan is very similar to 401(k) plans offered by for-profit businesses. Just like a 401(k) plan, a 403(b) tax-sheltered annuity plan gives employees the option to defer some of their salary into into individual, tax deferred investment accounts. The salary deposited is typically not subject to federal or state income tax until it's been distributed.
Those eligible for a 403(b) plan include employees of public schools or public colleges & universities, churches or charitable entities that are tax exempt under section 501(c)(3) of the Internal Revenue Code.
Contributions to the plan can be made one of three ways:
By the employer only
By the employee only
By both the employer and the employee
Employee contributions to a 403(b) plan can be made on a before-tax (salary reduction) basis or an after-tax (salary deduction) basis.
The funds are typically taken from the employee's paycheck prior to federal or state income taxes by the employer. Those funds are then deposited directly into individual tax deferred accounts. In many cases, the employees contributions are matched by the employer up to a certain amount per year. Because the employer can also make direct contributions, the employee gains that benefit of having additional tax-free funds accruing in that investment account.
These contributed funds and any gains earned are not taxed until the employee begins making withdrawals from the plan. When the money is withdrawn it is taxed as regular income. One thing to keep in mind is under most circumstances you are subject to a possible 10% tax penalty if you begin taking withdrawals and you're under the age of 59 1/2. Some exceptions to this 10% tax penalty rule would include your death or if you become permanently disabled, your medical expenses exceeding a certain percentage of your gross adjusted income in a year or being called to active duty for over hundred and 80 days. These rules and contribution limits can and do change so you will want to talk with you financial planer for the most up to date information.
Barring any of those events, you have until April the year after you turn 70 1/2 before the IRS requires you to begin receiving income from your TSA, however, if you are still employed after you turn 70 1/2 you may delay distributions until you finally do retire continuing to pay into your account through your employer if you wish.
When you do decide to retire, a 403(b) tax-sheltered annuity accounts typically provide a number of options for receiving your assets such as an income stream for life or the option of receiving payments over a certain period of years.
Some of the pros and cons to consider with the TSA or tax-sheltered annuity account would include flexibility in your contributions. With a 403(b) tax-sheltered annuity account you can increase or decrease or even stop and then restart your contributions depending on your situation. There may optional loans and hardship distributions available which can add some flexibility for employees if circumstances in their life or financial situation change unexpectedly. You will want to keep in mind that investment options are often limited to those chosen by your employer so you will have little say in how your funds are invested, although many of these plans have begun offering a wider range of investments in recent years, including many well-known mutual funds.
As with any investing decision, when determining whether a 403(b) tax-sheltered annuity plan is right for you, look at your entire financial situation, figuring out your goals and risk tolerance, either on your own or with the help of a financial professional and always keep your long-term goals in mind.
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