What it is The Advantages Who is eligible What it isn't Contributions Loans Distributions and Withdrawals Changing Jobs What It Is A 403(b) is a tax-deferred investment and savings program for employees of certain tax-exempt employers. It allows employees of hospitals, educational institutions, and other non-profit organizations to save and invest for their own retirement. Depending on your program, you authorize pre-tax payroll deductions to be invested in a tax-sheltered annuity (TSA) contract or in a custodial account made up of mutual funds offered by your organization. Both the contributions and the investment earnings can grow tax-deferred until withdrawal (assumed to be retirement), at which time they are taxed as ordinary income. 403(b)s were established by the federal government to encourage workers in certain tax-exempt organizations to establish retirement savings programs. The name refers to the relevant section in the Internal Revenue Code. The Advantage Tax-Deferred Contributions and Earnings Your contributions are taken pre-tax, reducing your taxable salary, and both the contributions and earnings can grow tax-deferred until they are withdrawn. Tax-deferred contributions and earnings make up the best one-two punch in investing. Compare the Results Choice and Portability If your organization sponsors a 403(b) program, you choose whether or not you want to participate. If the employer is involved in setting up the program and choosing a financial services vendor or vendors, the program must offer a number of different investment options, which means you get to select your investments based on your own time horizon, risk aversion, and financial risk tolerance. 403(b) investments are also portable. When you change jobs, you don't have to leave your 403(b) behind. You can roll over your account into another organization's 403(b) program or an IRA. Built-in Dollar-Cost Averaging* Because participant contributions are typically a percentage of an employee's salary, which is more-or-less the same every pay period, you invest the same amount every pay period. This is what's termed Dollar-Cost Averaging, a much-touted tenet of successful investing. To use the dollar-cost averaging strategy, you put the same amount of money into an investment at regular intervals, such as every month. Since, over the long term, the stock market has consistently risen, you are likely to end up buying more shares when prices are low and fewer shares when prices are high. And, you don't have to track the market and time your purchases (that is, buy low and sell high). * Dollar-cost-averaging involves continuous investment in securities regardless of fluctuating price levels of such securities and investors should consider their financial ability to continue purchasing through periods of low price levels. Dollar-cost-averaging does not assure a profit and does not protect against the loss in declining markets. Employer Contributions Employer contributions, which are optional, typically come in the form of what's called a "company match." These can range from 25% to 100% of your contribution to the program, up to a certain limit. Most employers offer this type of contribution--both as an incentive for employees to join the plan and as part of the overall benefits package. Many consider these employer contributions the real attraction of the 403(b) account. In a plan where your employer is matching your contribution at 50 cents on the dollar, you've made an instantaneous 50% return. In most cases, there is automatic vesting of employer contributions. Who Is Eligible? Depending on your organization's 403(b) rules, you may be able to contribute to a 403(b) in any year you earn a salary and are a regular employee. 403(b)s are designed for employees of certain 501(c)(3) non-profit institutions, including hospitals and health care organizations, charitable foundations, religious organizations, scientific and research organizations, educational institutions, and others. What It Isn't A 403(b) is different from an organization Pension Plan in several ways. Benefit. With a 403(b) program, benefits depend on individual contribution levels and portfolio performance. A Pension Plan has predetermined benefits based on final salary, years of service and a fixed percentage rate. Transferabilty. You can roll a 403(b) account into another 403(b) program or an IRA, but when you leave a company, your pension generally stays there. Investment Allocation Decisions. Each participant in a 403(b) makes decisions for his or her own portfolio. A Plan Administration makes decisions for the future "pensioners." Employee Contributions. The employee's contributions are supplemented by employer contributions in a 403(b) program. Company Pensions don't require or allow employee contributions. 403(b) programs are often called "401(k)s for non-profits." While this is generally true for most features, there are some differences: Employer Involvement. In a 403(b) program, employer involvement is not mandatory (beyond payroll). However, it is mandatory in a 401(k) plan for setting up, administering, and performing discrimination testing on the plan. Subject to ERISA regulations. Unlike a 401(k) plan, a 403(b)is only subject to ERISA regulations if there is employer involvement in setting up the program. Vesting Schedule. In most cases, vesting is automatic for a 403(b) program, while in most 401(k) plans, vesting occurs over a three to five year period. Type of Account. A 403(b) is a Custodial Account, a 401(k) is a Trust. Contributions Contributions to a 403(b) program can come from both employees and employers. Employee contributions are called salary reduction contributions, because they are pre-tax deductions taken from each paycheck, which reduces your taxable salary. Most programs do not allow after-tax contributions. Determining the maximum contribution limit for a 403(b) account can get complicated. For the 2002 tax year, the maximum contribution is the lesser of: $11,000 ($12,000 if age 50 or older by the end of the year) -- set by the IRS and indexed to inflation--or The MEA, or Maximum Exclusion Allowance--a calculation based on your compensation, your years of service, and your previous contributions to your current retirement plan. To determine what portion of your contribution is eligible to be excluded from your income for tax purposes, check with your benefits office or your tax adviser. Employer contributions, which are optional, typically come in the form of what's called a "company match." These can range from 25% to 100% of your contribution to the program, up to a certain limit. Most employers offer this type of contribution, both as an incentive for employees to join the plan and as part of the overall benefits package. Many consider these employer contributions the real attraction of the 403(b) account. In a plan where your employer is matching your contribution at 50 cents on the dollar, you've made an instantaneous 50% return. In most cases, there is automatic vesting of employer contributions. Loans Some programs allow loans to be taken from your 403(b) account. Once you reach a minimum balance (determined by the plan), you may be eligible to take a loan from your 403(b) account. Repayment takes place through automatic payroll deduction. In addition to repayment of loan principal, you also repay a fixed rate of interest to your account. In essence, you are borrowing from and repaying yourself. Taking a loan from your 403(b) account can have significant consequences for the growth of the account. You lose out on the earnings growth that would have occurred if the loan amount were still in the plan. Additionally, unlike some loans, the interest payments on 403(b) loans are not tax deductible. Because these programs are meant for retirement savings, there are usually restrictions, including those on loan frequency and loan amount, on the loans you can take from your program. Check with your benefits office for more details. Distributions and Withdrawals Withdrawals from 403(b) plans are often referred to as distributions. Assets in your 403(b) account can be withdrawn without penalty after age 59-1/2, and you must begin to withdraw money from your account no later than April 1 of the year following the year in which you turn age 70-1/2 unless you are still working. Distributions must be taken annually. Distributions taken after age 59-1/2 are subject to the following tax treatment: For pre-tax contributions: Both the contributions and the investment earnings are treated as income. For after-tax contributions: The contributions are treated as a nontaxable return of capital, but all investment earnings are treated as income. When you take a withdrawal the plan sponsor may be required to set aside 20% for federal withholding taxes. In most cases, an additional 10% premature withdrawal penalty will also apply for a withdrawal before age 59-1/2. If a plan allows hardship withdrawals, the rules are typically the same as those for 401(k)s. There are some exceptions to the 10% premature withdrawal penalty, including: Disability (as defined by the IRS) A separation of service (after age 55 and prior to age 59-1/2) If your withdrawal is distributed in the form of "substantially equal payments" made at least annually over your life expectancy or the joint life expectancy of you and your designated beneficiary Payments for certain unreimbursed medical expenses under the Internal Revenue Code Distributions to alternate payees required through Qualified Domestic Relations Orders (as might be issued in divorce proceedings) If you are considering taking a withdrawal, check with your plan sponsor or the IRS for more details. Changing Jobs When you change jobs, you have a number of options regarding your 403(b) account: 1) Roll it over into another 403(b) plan or an IRA You don't have to leave your 403(b) behind. You can roll over your account directly into another 403(b) plan or an IRA, called a Rollover (or Conduit) IRA. By doing so, you avoid any penalty or withholding tax. To ensure a direct rollover, be sure that your former 403(b) plan's custodian makes the check directly payable to your IRA's custodian or to your new 403(b) plan's custodian. 2) Take a lump sum distribution (full or partial) If you decide to take a distribution before age 59-1/2, the financial costs can be steep. In addition to a 10% premature withdrawal penalty, your plan sponsor is required to set aside 20% for federal withholding tax on the amount you don't rollover directly. This is only an estimate of the tax you'll owe on the withdrawal--the actual amount will be determined when you file your taxes. 3) Leave it where it is If the balance in the account is over a certain amount (currently $5,000), most programs will let you leave it there until age 70-1/2 or actual retirement, whichever is later. The tax information provided is for informational purposes only and is not intended, and should not be construed, as tax advice or a recommendation. Intuit does not provide legal, tax, or investment advice and you should consult with a professional tax advisor about your individual circumstances.