What is a 403(b)?
A 403(b), also known as a tax-sheltered annuity (TSA) plan, is a defined contribution retirement plan for employees of non-profit organizations, government workers and public school employees, such as professors, teachers, and school administrators.
A 403(b) lets workers set aside a portion of their paychecks in a retirement account before taxes are taken out. In addition, some employers contribute to their employees’ plans, often matching a portion of what employees set aside.
Workers can invest their contributions in mutual funds or annuities and reinvest returns on a tax-deferred basis, which can help their savings grow faster. Annuities are a product offered by insurance companies to help individuals set up a regular source of income. The products allow you to make a lump-sum payment or a series of payments, which then grow inside the product. At a later date, you receive regular payouts.
Annual individual contributions for a 403(b) are capped at $19,000 in 2019 and $19,500 in 2020. he combined contributions for both an employer and employee cannot exceed $56,000 a year in 2019 and $57,000 a year in 2020, or 100% of the employee’s most recent annual salary.
Employees with 15 years or more of service with a qualified organization may be eligible to contribute an additional $3,000 a year to their 403(b). Employees who are age 50 and older are eligible to make catch-up contributions of an additional $6,000 a year, or $6,500 in 2020.
Contributions to 403(b) plans and returns are tax-deferred. Individuals pay income tax when they make withdrawals from the accounts. You’ll need to wait until you are 59 ½ to withdraw funds penalty-free, otherwise you could be hit with early withdrawal penalties of 10% in addition to income tax.
When you reach age 70 ½ you must make required minimum distributions every year. The government determines how much you are required to withdraw based on account balance and your life expectancy.
What is a 401(k)?
Employers in the private sector may offer their employees a 401(k) retirement plan as part of their benefits package. Like 403(b) plans, 401(k)s are tax-deferred savings vehicles designed to help employees save for retirement.
Just like with a 403(b), employees with a 401(k) make pre-tax contributions directly from their paychecks. Neither employee contributions nor the earnings on investments are taxed until employees withdraw the funds when they retire, or after age 59 ½. Like 403(b)s, employers may make matching contributions to employee accounts.
401(k) plan contribution limits are the same as for 403(b) plans—$19,500 a year for individuals and $57,000 for combined employer/employee contributions in 2020, up from $19,000 a year for individuals and $56,000 in combined contributions in 2019. People age 50 and older are eligible to make catch-up contributions of an additional $6,500 a year in 2020, up $500 from the year before. As with a 403(b) plan, funds withdrawn from a 401(k) before age 59 ½ are subject to a 10% early withdrawal penalty.
When it comes to how you invest, 401(k) plans typically offer a limited set of investments to choose from, such as a handful of mutual funds, target-date funds and exchange-traded funds. Though rare, it’s possible that a 401(k) may also include annuities as part of its offerings.
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