403(b)

The 403(b) is a tax deferred, defined contribution plan available to employees of educational institutions such as public school districts and certain (Internal Revenue Code section) 501(c)(3) non-profit groups, which include colleges, universities, hospitals, charities and the clergy.

The 403(b) has a long history and a long association with the insurance industry. History of the 403(b) Plan Sources:
 * 403(b) programs were originally created in 1958 by Congress for employees of tax-exempt corporations.
 * In 1961, public education institutions, including public school districts, became eligible to offer 403(b) plans.
 * In 1973, Congress passed a law allowing employees to make tax-free exchanges of the full account value from one 403(b) plan to another, and partial transfers have been allowed since 1992.
 * In 1974, Congress passed the Employee Retirement Income Security Act (ERISA), which included a provision allowing 403(b) plans to increase the number of their investment options and offer mutual funds in addition to annuities.
 * In 1978, a law was passed allowing employees to roll 403(b) assets into a traditional IRA.
 * Starting in 1982, with the passage of the Tax Equity and Fiscal Responsibility Act, 403(b) participants were allowed to take loans from their plans. Additionally, religious organizations were permitted to set up Retirement Income Accounts, a specialized form of 403(b) plan.
 * In 1986, another tax law imposed restrictions on withdrawals before age 59½ and made them subject to a 10 percent early withdrawal penalty. Additionally, required minimum distributions (after age 70½) were established along with new limits on elective deferrals. The limit established then, $9,500 per person per year, remained in effect until 1998.
 * A 1992 IRS ruling allowed employees to make tax-free full or partial account transfers from annuities to 403(b)(7) mutual fund accounts.
 * The 2001 tax bill, which took effect in 2002, allowed 403(b) participants to roll their money into a 401(k) or governmental 457 plan when changing jobs, in addition to an IRA or other 403(b). Similarly, employees with savings in 401(k) or governmental 457 plans may roll their contributions into a 403(b) plan, if offered by their new employer. The tax bill also simplified the formula used to calculate an employee's annual contribution limit.
 * On July 23, 2007, the IRS finalized new regulations (set to go into full effect January 1, 2009) for public 403(b) retirement plans. The main highlights include:
 * Requirement that a 403(b) program be maintained pursuant to a written plan which satisfies section 403(b) in both form and operation and contains all the terms and conditions for eligibility, limitations, and benefits under the plan.
 * End to traditional 90-24 outside-of-plan transfers.
 * Requirement to provide annual notification of eligibility
 * Clarification of universal availability
 * New information sharing requirements between employers and vendors.
 * http://www.403bexpert.com/15.ht
 * http://www.403bwise.com/employers/getwise_regulations.html The following table provides a summary of 2012 year end 403(b) assets as well as the distribution of assets across annuity and mutual fund investment platforms.

Summary
Contributions to a 403(b) plan are tax-deductible, and any earnings accumulate tax-free until withdrawals are made. Withdrawals are taxed at ordinary income rates, and a 10% penalty tax is assessed on withdrawals made prior to the age of 59 ½, unless one meets one of the following exclusions:
 * Attain age 59-1/2
 * Separate from service in or after the year in which you reach age 55
 * Part of a series of substantially equal periodic payments for your life or the joint lives of you and your designated beneficiary
 * Hardship
 * Disability
 * Death
 * Made due to an IRS levy upon your participant account
 * Paid to an alternative payee under a qualified domestic relations order
 * Is a qualified reservist distribution as defined under the Pension Protection Act of 2006
 * Is a payment of qualified medical expenses greater than 7.2% of your adjusted gross income.

Roth 403(b)
Beginning in 2006, 403(b) plans have been allowed the option of providing a Roth 403(b). The Roth 403(b) allows individuals to contribute after-tax dollars to grow tax free and not be taxed upon withdrawal. If the plan contains a Roth option, an employee can direct 403(b) contributions to a regular 403(b), a Roth 403(b), or some combination of the two plans; the total contribution cannot exceed the annual contribution limit.

A Roth 403(b), is generally subject to required minimum distributions after you have retired and attained age 70½. . To avoid required minimum distributions, an individual can execute a trustee-to-trustee transfer of the Roth 403(b) account to a Roth IRA upon terminating employment.

A Roth 403(b) may be attractive under the following circumstances:
 * If you expect your tax rate in retirement will be higher than it had been during the years you contributed.
 * If you are young and want to use a long investment horizon to accumulate tax-free earnings under a Roth feature.
 * If you are a highly compensated individual who would like to have a pool of tax-free money to draw upon after retirement, and who are not eligible for Roth IRAs due to the income limitations.
 * If you want to leave tax-free money to heirs.

Contributions
Employees may contribute up to 100% of their salaries, subject to the following limits:

Employees with 15 or more years of service with public school systems, hospitals, home health service agencies. health and welfare agencies, churches, or convention or associations of churches may be able to defer an extra $3,000 in catch-up contributions (to a lifetime maximum of $15,000). In the ordering of contributions, the IRS deems that the 15 year service catch-up contributions precede the age 50 catch-up contributions.

Advantages
The advantages a 403(b) plan offers include the following.


 * High contribution limits allow an individual to tax defer more investment dollars than can be contributed to individual retirement plans.
 * Contributions to a regular 403(b) are tax deductible. Tax deductible contributions are especially advantageous if the tax rate is lower when retirement income withdrawals are made. If a Roth option is available, contributions made at low tax rates are advantageous if the tax rate is higher when retirement withdrawals are made.
 * Contributions made to a 403(b) qualify for the Retirement Savings Contributions Credit (Saver's Credit) if you meet the filing and income requirements.
 * Employer's can make matching contributions to employee contributions.
 * Some plans may have loan provisions.
 * 403(b) plans allow employees who have fifteen years of service to an employer to make up to $15,000 of catch up contributions to the plan.
 * Particicipants who are eligible for a both 457(b) and a 403(b) through their employer can contribute the maximum of both plans, which at $17,500 each is a combined $35,000. See 457(b)wise FAQ for more information.

Criticisms
Since the 403(b) is heavily tied to the insurance industry, a common option of 403(b) plans is a tax-sheltered fixed annuity or a variable annuity. These products often come with an extra layer of fees and restrictions such as surrender charges; furthermore, the extra tax-deferral features of the annuity are unnecessary since the 403(b) is already a tax-deferred account.

Mutual funds are a possible option only if they are an available option within the plan. If mutual funds are not available in the 403(b) the participant should consider lobbying the employer to offer some lower fee mutual funds. If you are in this situation see How to Campaign for a Better 401(k) Plan for information on how to proceed.

Simon's commentary
W. Scott Simon, who writes a monthly Fiduciary Focus column for Morningstar has an eight part series on the 403-b Plan universe. These plans have been affected by regulation changes effective since January 1, 2009. This series is especially valuable for 403-b plan providers.


 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 1)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 2)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 3)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 4)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 5)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 6)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 7)
 * Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 8)