403(b) & 457(b) Fundamentals
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403(b) & 457(b) Fundamentals Topics
What is a 403(b)?
403(b)s are retirement savings plans that allow employee contributions to grow tax-deferred or tax-free until withdrawn in retirement. A 403(b) plan is similar to a 401(k) plan in that it’s
an easy way to save for retirement and benefit from pretax or Roth salary deferrals, except a 403(b) is designed for employees of the following types of organizations:
- Public education institutions – elementary and high schools, colleges and universities
- Churches or church-related organizations
- 501(c)(3) tax-exempt organizations like hospitals, museums and more
403(b)s are offered through your employer and the contributions you make come directly from your paycheck. With traditional tax-deferred investing, you can contribute on a pretax basis and your contributions and earnings grow tax-deferred. Over time, this tax-deferred compounding can have a dramatic impact on your retirement savings. The Roth feature offered by some 403(b) plans lets you fund your retirement account with income that’s already been taxed, and contributions and their investment earnings can be withdrawn tax free.
There are four types of 403(b) products available to participants. Those four product types are:
Mutual Fund product (also called a 403(b)(7) custodial account):
This type of product allows participants to invest their contributions in mutual funds. This type of account is not an annuity or a life insurance product. Returns on contributions depend on the performance of the mutual funds selected.
Variable Annuity product:
A variable annuity is a contract with an insurance company under which you contribute into a tax–deferred account. In return, the insurer agrees to make periodic payments at retirement or some future date. You can choose to invest contributions in a range of investment options, which are typically mutual funds. The value of the account in a variable annuity will vary, depending on the performance of the investment options chosen. In this sense, it is similar to a mutual fund product except it is offered as a life insurance product and involves a contractual agreement.
Fixed Annuity product:
A fixed annuity is a contract with an insurance company that guarantees a minimum rate of return during the time that your account is growing. The insurance company also guarantees that the periodic payments in retirement are guaranteed for an established amount of time. Details of the minimum rate of return and payout schedule are established when the contract is signed. In some instances, the insurance company will charge additional fees for features and guarantees.
Equity Indexed Annuity product:
A specific type of fixed annuity contract between you and the insurance company. During the period of time where you make contributions, the insurance company credits a return that is based on changes in an equity index, such as the S&P 500 index. The insurance company sometimes also guarantees a minimum rate of return. In retirement or on a future date, the insurance company will make periodic payments to you under the terms of your contract. In some instances, insurance companies will charge additional fees for features and guarantees.
Vendors are the entities that register and offer their 403(b) products to district employees. A vendor will have at least one 403(b) product and sometimes will have many 403(b) products available for you to participate in. Vendors are required by law to register their 403(b) products on 403bCompare,
so if you are being offered a product that you are unable to find on 403bCompare, please contact the 403bCompare administrator immediately at 844-488-0270.
It is important to set your employer on the 403bCompare site so that you are researching and browsing vendors approved by your employer. Once you have completed this step, it is important to research a vendor’s experience, financial strength and services offered. A 403(b) product is only as good as the vendor offering it.
All employees —certified and classified— of the employer types below may participate in the 403(b) plan maintained by the employer:
- A tax-exempt organization established under section 501(c)(3) of the Internal Revenue Code - these organizations are usually referred to as section 501(c)(3) organizations
- Public school systems
- Cooperative hospital service organizations
- Uniformed Services University of the Health Sciences
- Public school systems organized by Native American tribal governments
- Certain ministers
Why should I contribute to a 403(b)?
For most employees, their defined benefit pension check alone will not be enough in retirement. A 403(b) defined contribution plan can help supplement their retirement savings.
How do I start contributing?
Use the My Next Steps tool provided on 403bCompare. This tool walks you through the following steps:
- Select your employer
- Select your product
- Enroll with the vendor that offers the product
- Complete your employer’s Salary Reduction Agreement to start contributing
Written Plan Document
As of 2009, a 403(b) plan must have a «written plan document.” A written plan document must contain all the material terms and conditions for eligibility,
benefits, applicable limitations, contracts available, and the time and form under which distributions would be made. It must include information on hardship distributions, loans, transfers,
rollovers, optional provisions, and more.
You can review your employer’s written plan document by visiting your employer’s page on 403bCompare (if your employer provided the document). If it is not available on 403bCompare, contact your employer and request a copy.
Visit Retirement Topics - 403(b) Contribution Limits for up–to–date contribution limits.
Before–tax, After–tax (Roth) contributions
Some employers allow you to elect to make contributions before-tax or after-tax (Roth), while other employers only allow for before-tax contributions. Reference your employer details page on 403bCompare to see if they allow for both before-tax and after-tax (Roth) contributions.
Making a before–tax contribution means your money goes into your 403(b) account before federal and state taxes are withdrawn. With this type of contribution you can place more money into your account while minimizing the impact of take–home pay. Taxes are applied when you take withdrawals in retirement.
Making an after–tax (Roth) contribution means your money goes into your 403(b) account after federal and state taxes are withdrawn. With this type of contribution, your withdrawals in retirement are not taxed.
If you withdraw assets prior to age 59½, the IRS will impose a 10 percent penalty tax on the amount to be included in your taxable income in addition to the normal tax consequences, unless you meet one of the following criteria:
You separate from service during or after the year you reach age 55. This exception is permitted by §72(t)(2)(A)(v). See irs.gov for more information.
Retire before age 55 and arrange a schedule of Substantially Equal Periodic Payments. The payments are based on an IRS formula and must continue for five years or until the individual reaches age 59½, whichever takes longer. This exception is permitted by §72(t)(2)(A)(iv). See irs.gov for more information.
Separate from service and move money to a tax-favored account such as another employers plan or a Rollover IRA
- You receive a distribution for medical care for deductible medical expenses (medical expenses that exceed 7½ percent of your adjusted gross income), whether or not you itemize your deductions for the year.
Depending on any restrictions imposed by your employer or 403(b) vendor, the IRS limits loans to the lesser of $50,000 or 50 percent of your account value.
Contact your 403(b) vendor to find out about any loan fees and loan interest rates. This information can also be found in the vendor and product details of 403bCompare.
A 403(b) plan may, but is not required to, provide for hardship distributions. Many plans that provide for elective deferrals provide for hardship distributions. If a 403(b) plan provides for hardship distributions, it must provide the specific criteria used to determine a hardship. For example, a plan may provide that a distribution can be made only for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition and education expenses. In determining if a need exists and the amount necessary to meet the need, the plan must specify and apply nondiscriminatory and objective standards. Information regarding hardship distributions can be found in the written plan document.
Required Minimum Distributions
Your required minimum distribution is the minimum amount you must withdraw from your 403(b) account each year. You generally have to start taking withdrawals from your 403(b) retirement plan account when you reach age 70½.
You can withdraw more than the minimum required amount.
- Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth 403b).
Range of Services Offered by Vendors
Establishing and maintaining a 403(b) retirement savings account can be tricky. Some participants may need counseling and education to help make important decisions. There are some vendors that provide a range of services designed to help potential and existing participants make those important decisions. 403bCompare asks vendors to provide a description of the services they offer. The details can be found on each vendor’s details page and in the vendor details tab when comparing products. Below is a listing of the range of services that could be provided by vendors:
- Online account access
- Rollover assistance
- Financial literacy workshops
- Online budgeting & financial tools
- Toll–free customer service line
- Commission free advice and services
- No load investment options
- Self-directed brokerage account
- Asset-allocation planning
- Portfolio rebalancing program
- Dollar cost averaging
- Required minimum distribution services
Fees and Charges
Product Fees (Vendor Fees)
There are potentially three layers of fees and charges that participants should be aware of. Those layers are 403(b) product fees (vendor fees), investment fees, and employer/third-party administrator fees. Let’s look at product fees first.
Product fees are those fees charged by the vendor offering you the 403(b). These fees are in place to cover the vendor’s cost of providing and administering a 403(b) plan. Examples of product fees are:
- Administrative fee
- Custodial fee
- Recordkeeping fee
- Mortality and expense fee
- Loan origination fee
- Surrender fee
- Rider fee
- Advisor fee
- Brokerage fee
- Account closeout fee
These are just some examples of product fees and there are more. Some products have more fees than others. That’s why it is important to compare the fees using the 403bCompare product comparison tool.
Some products claim to have no fees. Be wary of these products. They typically are products that have a low fixed rate of return. The return is low because they are taking their fees out of your returns. Hence, they are “baked into the product” itself.
Investment fees are those fees that are associated with the individual investment options offered within your 403(b) account. When comparing different products it is important to also compare a product’s investment fees. Examples of investment fees are:
- Administrative fee
- Front-end load
- Back-end load
- Redemption fee
Expense ratios cannot be avoided; however, there are some 403(b) products that offer investments with lower expense ratios. Use the average expense ratio meter on 403bCompare to gauge a product’s average expense ratio in comparison to all products.
Front-end and back-end loads are ways for the sales reps selling you the 403(b)product to earn commissions off of your contributions. They are not included in most investment options, so you should definitely ask for “no load” investment options if they are available. If the 403(b) you are participating in does not offer any “no load” investment options, you should look around for another 403(b) product.
Employer/Third-Party Administrator Fees
Some employers contract with a third-party administrator to help manage the transfer of employee contributions from their paycheck to their 403(b) account. The third-party administrator also ensures that the employer’s 403(b) remains in compliance with IRS guidelines. Third-party administrators will cover the cost of these services by either charging participants directly or by charging the vendors offering 403(b) products. These fees can sometimes be seen on your quarterly 403(b) account statements.