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What Is a 403(b)? A 403(b) is a tax-deferred retirement plan that can be established by two general categories of employers: schools (public school systems, state colleges and universities) and tax-exempt 501(c)(3) organizations (charities, hospitals and religious organizations). In a typical 403(b) plan, employees in a qualifying organization defer a portion of their salaries into individual accounts according to a salary reduction agreement with the employer. The salary reduction agreement applies to the employee’s future earnings. If the agreement is ever modified, the modification will only affect the employee’s subsequent earnings. Salary deferrals, while exempt from current federal income tax up to certain limits, are still subject to Social Security and Medicare withholding taxes. The employer may also make contributions up to certain limits.
Are There Contribution Limitations? There are limits to how much an employee can defer into the account each year depending, among other things, on the person’s age. The 2017 limit is $18,000 ($24,000 for people age 50 and over). However, for participants with 15 years of service or more with the employer, the annual limit is increased by an additional $3,000. There’s also an overall limit on annual additions to the account from all sources—including any employer contributions. In 2017, the limit is 100% of the employee’s compensation or $54,000, whichever is lower.
What’s the Tax Treatment? Amounts deferred into the 403(b) plan are not currently taxed to the employee unless made on an aftertax basis, including those designated as Roth deferrals. Earnings inside the account accrue on a tax deferred basis until they’re withdrawn. Employer contributions are deductible by the employer in the year they’re made. Employee withdrawals from the 403(b) account—except amounts representing a return of the employee’s nondeductible contributions—are taxed as ordinary income. Roth deferrals are the exception, as they may be withdrawn tax free when certain requirements are met. The special tax treatment available for lump-sum distributions to certain grandfathered participants in other qualified retirement plans is not available to 403(b) participants.
What About Distributions? Withdrawals from a 403(b) plan prior to the employee’s age 59½ may incur a 10% penalty tax unless certain exceptions apply. Distributions generally must begin no later than April 1 of the year following the year the participant reaches age 70½. Distributions may, however, be deferred until the participant’s actual retirement if that is later than age 70½.