A tax-deferred retirement plan for laborers who work in public sectors.
Essentially, employees contribute part of their salary into a retirement plan known as the 403(b) plan. These can be in the form of safe investments or high-risk ones. Usually, each workplace's human resources representative will recommend what investments to make depending on what the employee wants. Each individual is free to contribute as much of their salary to the plan as they please. They just cannot surpass the basic contributions limit, which, as of 2021, is $19,500 a year.
The 403(b) retirement plan is fairly similar to the 401(k). The main difference between the accounts is the people who are eligible for these insurances. 401(k)s are for laborers who work in private sector for-profit companies. 403(b)s are for laborers who work in public sectors, like public schools, police and fire stations, public hospitals, etc. Also, in some 401(k) instances, private organizations contribute to the workers' accounts. These organizations invest money into their accounts as an incentive to help them save for their retirement. Public workers with 403(b) plans will rarely receive such investments from their employers and are more on their own when it comes to their retirement plans.
According to the IRS website, there are four main types of contributions that you can make to a 403(b) retirement plan:
- Elective Deferrals: An agreement between the employer and employee to directly deposit an agreed-upon amount from the employee's salary into the plan.
- Nonelective employer contributions: Contributions made outside of the employee's work salary. These contributions are taxed only after you withdraw them.
- After-tax contributions: Contributions that were part of the employee's gross income for income tax purposes.
- Designated Roth contributions: Roth contributions have separate accounting records from all other contributions. It's a separate plan where the funds are after-tax.
Example of a 403(b) Plan
When an individual gets a 403(b), as previously mentioned, all the money invested is tax-deferred. For example, let's take a worker that makes $14,000 a year and has a 10% tax rate. If he does not have a 403(b) retirement plan, then his tax liability remains $14,000, and he will end up paying $1,400 in taxes just from his income. Next year, he decides to acquire the 403(b) plan and invests $1,000. That $1,000 invested affects the worker's tax liability. Assuming his yearly income and tax rate remain the same as last year, instead of paying 10% of $14,000, he'll only have to pay 10% of $13,000, or $1,300 in total.
If the worker hasn't been contributing to the plan for some years and decides to start saving, there is an option that helps to catch up. .The 403(b) retirement plan has a catch-up system where the employee can contribute an additional $3,000 if they've worked 15 or more years with certain non-profit agencies. This individual will be able to withdraw all of his savings after the age of 59 1/2. Should the money be withdrawn before the employee is of that age, then there will be a 10% penalty fee when withdrawing.