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Summary
If you are employed by a non-profit corporation or an educational institution you can participate in a 403(b) account.
In Depth Analysis
Your ability to participate in a 403(b) program in great part depends who you are employed by. Your employer must qualify under one of the following categories:
A tax-exempt organization established under section 501(c)(3) of the Internal Revenue Code. These organizations are usually referred to as 501(c)(3) organizations or 501(c)(3) non-profit corporations
- Employees of Public and Non-Profit Schools.
- Employees of cooperative hospital service organizations.
- Employees of public schools organized by Indian Tribal Governments.
- Certain Ministers.
Each employer may have certain requirements to meet eligibility such as only full time employees, or only after completing a probationary period. Check with your employer to see if they impose any conditions on eligibility before you can begin participation.
Once you have established eligibility you must establish a 403(b) account with an approved provider and submit a salary reduction agreement (some times referred to as an elective deferral form) to your employer. In order to establish what your contribution level is for the tax year, please go to the ANNUAL DEPOSIT discussion in this section.
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Summary
General guideline for 403(b) deposits is 100% of your annual salary not to exceed $42,500, or the maximum elective deferral of $15,500 (2007-2008 maximum), which ever is less. There are additional amounts that can be added based on your age and your length of service with your employer.
In-Depth Analysis
Contributions to 403(b) accounts may be made by Elective Deferral under a salary reduction agreement with your employer. It is an agreement not to receive income but instead to deposit it into a 403(b) account. Your employer may also make non-elective contributions to your account. The contributions made by your employer can be a matching arrangement, a discretionary contribution or a mandatory employer contribution. After tax contributions can also be made to a 403(b) account, but only if allowed by your plan. All deposits must be made into the account by your employer.
Calculating what you can contribute each year has been the most confusing areas of the 403(b) programs. But, with the changes that took place in 2002, they have been simplified. Three basic factors must be taken into account when determining a deposit into your account each year: your annual income, your age and the number of years you have worked for your current employer.
The calculation limit is 100% of your salary, not to exceed $42,500. You must then take the lesser of that amount or the maximum limit for 2007/2008 which is $15,500. This limit can be increased under certain circumstances.
Maximum deposit levels increased beginning in the year 2002. The Elective Deferral maximum is $15,500 for 2007/2008. If you are 50 years of age or older an additional $5,000 may be added to the $15,500 for a total of $20,500. If you have 15 years of employment with your current employer, you may add $3,000 per year to the limit for 5 years. For tax years after 2002, the limits increase as follows:
| Year |
Limit |
Over 50 |
5 year catch up |
Total |
| 2002 |
$11,000 |
$1,000 |
$3,000 |
$16,000 |
| 2003 |
$12,000 |
$2,000 |
$3,000 |
$18,000 |
| 2004 |
$13,000 |
$3,000 |
$3,000 |
$20,000 |
| 2005 |
$14,000 |
$4,000 |
$3,000 |
$22,000 |
| 2006 |
$15,000 |
$5,000 |
$3,000 |
$24,000 |
| 2007 |
$15,500 |
$5,000 |
|
$20,500 |
| 2008 |
$15,500 |
$5,000 |
|
$20,500 |
Your voluntary deposits are known as Salary Reductions or Elective Deferrals. Deposits are deducted from your per pay period salary before Federal and State taxes are calculated and reduce your W-2 income as reported on April 15th of each tax year. However, 403(b) deposits continue to be subject to Social Security and Medicare fringe benefit taxes.
The additional elections for certain groups: employees of public schools or the public schools system, hospitals, home health service agencies, churches or church related organizations have been eliminated with the exception of the year of separation from service.
The alternative limits are:
The Year of Separation from Service Election, which is100% of salary or $40,000, which ever is less. This election will still require a Maximum Exclusion Allowance calculation. When calculating the MEA for this election only the last 10 years of service.
There are additional limitations that must be taken into account if you are making contributions to a 401(k) or 457 plan with the same employer in addition to a 403(b) plan.
For further assistance in establishing deposit levels, check with your current 403(b) provider or tax consultant. You may also email WASI or call for additional information.
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Withdrawals can be made from 403(b) accounts at anytime. Requests made while you are still employed and making deposits can only be made due to a medical disability or because of a financial hardship. Financial hardship falls into four basic categories:
- Eligible medical expenses for yourself, spouse or dependents,
- Direct cost for purchase of a principal residence,
- Eligible educational expenses for yourself, spouse or dependent,
- Threatened eviction from, or mortgage foreclosure on your principal residence
When funds are withdrawn for financial hardship reasons, your ability to make future deposits may be suspended for a six-month period of time.
Once you reach age 59 ½ or you separate from service from your employer, your funds are available at anytime. All withdrawals are subject to an automatic federal withholding tax of 20% of the amount withdrawn. If you are under 59 ½ you may also be liable for a 10% early withdrawal federal penalty tax plus a penalty tax from your state.
If loans are available from your plan, it might be a less punitive method of using funds in your account. Please see the section on loans from 403(b) accounts.
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403(b) accounts have three options for investments: a fixed annuity from an insurance company, a variable annuity from an insurance company or mutual funds. Mutual funds may be obtained either from a mutual fund family or through a custodian bank.
A fixed annuity is an annuity contract issued by a life insurance company. Fixed annuities generally pay a current fixed rate of interest. Each fixed annuity contract will have a guaranteed interest rate as a base, below which the fixed rate cannot fall. Fixed rate contracts generally pay rates of interest that are market sensitive. They are loosely linked to the bond markets and/or generally interest rates being set by government agencies. Costs associated with fixed annuities generally are withdrawal penalties based on the number of years the contract is owned, or a length of time for each deposit. Withdrawal penalties can be significant in relation to the total value of the account, or can be a minor sum.
A variable annuity is a hybrid between a fixed annuity and mutual funds. The fixed annuity portion of the account is as described above. A second investment structure is added in the form of mutual funds either sponsored by the life insurance company directly, or taken from existing mutual fund families. This type of account allows the holder to have both a fixed account and to place other portions of their funds in potentially higher yielding securities. A word of caution on utilizing these types of accounts are the expenses that are charged by both the fund companies and the insurance company: dual expenses can amount to load fees from the fund companies and mortality expense ratios charged by insurance companies and may cost the holder a significant percentage of their account each year.
403(b) 7 accounts or 403(b) 7 custodial accounts utilize only mutual funds as the investment. Accounts can be set up with a single mutual fund family or as a custodial account that allows extensive use of a significant number of different funds from a variety of mutual fund families. The later is preferred in the event that the holder wishes to have a variety of options available for investment purposes rather than a single fund family. This type of account also allows the investor to changes fund investments without having to establish multiply accounts at different fund families in order to achieve fund diversification. In either case, investments can be made into load funds, no-load funds or a variety of combinations. There are aggressive, growth, value, and bond & balanced funds to choose from.
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403(b) accounts can be transferred from one 403(b) account to another at anytime. The account holder initiates the process by establishing a second 403(b) account. A request is then made to the original account for all or part of the original account to be transferred to the new account on a direct custodian-to-custodian basis. The funds that are transferred in this manner are not subject to income tax or tax penalties since it is merely an exchange not a withdrawal. Funds transferred in this manner are usually lumps, one time only events. There are no restrictions as to the number of times custodian-to-custodian transfers may be made.
A second type of transfer is referred to as a 90-24 Transfer. 90-24 Transfers were first allowed in 1990 with IRS Ruling 90-24. Prior to the passage of this ruling, all transfer had to be completed within 24 months. Revenue Ruling 90-24 extended the transfer time allowed from 24 months to 10 years. This change allows a tax-free transfer to take place in monthly or quarterly payment over to a new account, and, as long as the transfer is completed within 10 years, it qualifies as a tax-free exchange and is not subject to income taxes or tax penalties.
A word of caution concerning transfers: Although there are no taxes or tax penalties on the transfer, there may be a withdrawal penalty or charges of some type if you move your funds from one investment to a second investment. In addition, existing loans against the account are generally not transferable to a new custodian, especially if they are in default. Attempts to transfer accounts with outstanding loan balances may result in a taxable event to the account holder. Therefore, a thorough review of all aspects of the account, the investments and the complexity of the transfer should be made prior to any specific action taking place. Some withdrawals can be extremely costly and should not be undertaken without a comprehensive review.
RMD (Required Minimum Distributions) made as a result of the account holder reaching age 70 ½ years of age may not be transferred to another qualified retirement account. However, there are no restrictions on transfers not deemed to be MDR amounts even after age 70 ½ years of age.
Since transfers require extensive paperwork in order to be accomplished, it can take considerable time and should be completed properly from the outset; all paperwork should be accurate and legible in order to avoid delays and mistakes. WASI can assist in the process of completing all necessary paperwork.
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Rollovers from 403(b) accounts generally occur when the account is transferred from a 403(b) account to a tax qualified account other than a 403(b) account, such as an IRA or a 457 Plan or a 401(k). 403(b) accounts may now be rolled over to any other qualified account if a triggering event takes place. A triggering event is either separation from service from the employer where the 403(b) account was originally started or attainment of age 59 ½.
A rollover can be either from one custodian to another custodian or it can be funds paid directly to the account holder and the account holder deposits the funds into the new rollover account. Funds paid directly to the account holder may have had taxes withheld from the distribution amount. The account holder is allowed to replace the amounts withheld and deposit the full amount of the original account to the new account. When tax returns are filed at the end of the tax year, the amounts withheld will be returned as a tax refund.
A word of caution concerning rollovers: Although there are no taxes or tax penalties on the rollovers, there may be a withdrawal penalty or charges of some type if you move your funds from one type of account to a second account. If there are existing loans against the account, they are generally not transferable to a new account, especially if they are in default or the new account does not have loan provisions. Attempts to transfer accounts with outstanding loan balances may result in a taxable event to the account holder. Therefore, a thorough review of all aspects of the account, the investments and the complexity of the transfer should be made prior to any specific action taking place. Some withdrawals can be extremely costly and should not be undertaken without a comprehensive review.
RMD (Required Minimum Distributions) cannot be rolled over into another tax-qualified plan. If funds are being rolled over on a 90-24 transfer on a direct basis, some companies will not continue to pay funds into a new account, but will instead re-direct funds directly to the account holder. Consequently, the account holder must re-deposit the funds into the new account and recognize the transfer on their individual tax return each year until the transfer is completed.
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Deposits made to a 403(b) account are not subject to income tax withholding (federal and state) when withheld from a participants wages. Deposits are subject to FICA taxes and SDI (state disability taxes) where applicable. Annually, the total amount deposited into a 403(b) account will reduce the W-2 income reported to the Internal Revenue Service. The amount of the deposits will be noted on the W-2, but are not to be included in taxable income for the year.
Income taxes are due when funds are withdrawn from the account. Amounts withdrawn are considered as ordinary income and are taxed accordingly for the year that they are withdrawn. However, withdrawals are considered unearned income and will not act to reduce Social Security income benefits if withdrawn prior to age 65.
Funds withdrawn prior to age 59 ½ may be subject to an early withdrawal tax penalties of 10% of the amount withdrawn for federal taxes and 2.5 % of the amount withdrawn for state taxes (California). Penalties may be waived in the case of medical expenses and educational expenses. If funds are being withdrawn as retirement income prior to age 59 ½ years of age on either a lifetime income basis or in a manor in which the account will not be exhausted by age 59 ½ , penalties are generally waived.
Funds being withdrawn on a systematic basis, either monthly or annually, can have taxes withheld on a flat percentage basis of 20% or by submitting a W-4P to establish a standard withholding amount, taxes can withheld as they would from a normal paycheck. If the distribution is considered a partial distribution, a mandatory 20% will be withheld.
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403(b) accounts have mandatory distribution requirements that begin in the year you reach age 70 ½. The minimum amount that must be withdrawn is based on a life expectancy table provided by the IRS and shown below. The percentage is based on a unisex life expectancy table and represents life expectancy at each age. The amount required for distribution is based on the value of the account(s) of the first day of each year. All 403(b) account must be combined to calculate the required distribution amount, but the amount can be withdrawn from a single account rather than from each account separately. Withholding taxes are withheld from RMD payments with the filing of a W-4P withholding form. If payments are requested that exceed the RMD calculation for the year, withholdings will be at a minimum of 20% of the amount distributed above the RMD calculation for the year.
| Age |
Life Expectancy |
MDR % |
| 70 |
26.2 |
3.82% |
| 71 |
25.3 |
3.95% |
| 72 |
24.4 |
4.10% |
| 73 |
23.5 |
4.26% |
| 74 |
22.7 |
4.41% |
| 75 |
21.8 |
4.59% |
| 76 |
20.9 |
4.78% |
| 77 |
20.1 |
4.98% |
| 78 |
19.2 |
5.21% |
| 79 |
18.4 |
5.43% |
| 80 |
17.6 |
5.68% |
| 81 |
16.8 |
5.95% |
| 82 |
16 |
6.25% |
| 83 |
15.3 |
6.54% |
| 84 |
14.5 |
6.90% |
| 85 |
13.8 |
7.25% |
| 86 |
13.1 |
7.63% |
| 87 |
12.4 |
8.06% |
| 88 |
11.8 |
8.47% |
| 89 |
11.1 |
9.01% |
| 90 |
10.5 |
9.52% |
| 91 |
9.9 |
10.10% |
| 92 |
9.4 |
10.64% |
| 93 |
8.8 |
11.36% |
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Tax penalties arise in certain circumstances. An over contribution made during a tax year will result in an excess contribution penalty of 6% if the over contributed amount is not removed by March 5th of the year following the over contribution. If the over contributed amount is not removed from the account, it is considered as a contribution for the following year; however, the penalty will still apply.
Tax penalties generally refer to amounts withdrawn prior to an individual reaching age 59 ½ years of age. Early withdrawal federal penalties amount to 10% of the amount withdrawn and are in addition to any taxes due. A state tax penalty may also apply (California sets it's penalty at 2.5% of the amount withdrawn). Penalties may be avoided prior to age 59 ½ if funds are removed in a systematic basis on a payment schedule as retirement income. Payments must continue past age 59 ½ in order to not be penalized. Penalty taxes may be waived if the early withdrawal is for medical or educational purposes.
Funds must begin to be withdrawn at age 70 ½ unless the account owner is still employed and still contributing to the account; however, this exemption only lasts until age 75. If Minimum Distribution Requirements are not met each year, a penalty of 50% of the amount that should have been withdrawn will be assessed. If employment continues past age 75, contributions may continue to be made, but withdrawals will also be required.
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403(b) accounts are individually owned by each participant. When they are initially setup, the accounts are set up with the participant as the owner. The employer's participation is limited to withhold funds from the participant's wages and transmitting those funds to the account selected by the participant. Once funds have been deposited into the account, the employer's responsibility ceases.
As the owner of the account, the participant makes all decisions concerning the investment, re-investment or transfer of the funds. At termination of employment by the participant, nothing needs to be done to the account ownership since the account is already in the participant's name. If loans are outstanding at the time of termination, no change in their structure is necessary since it is solely the responsibility of the participant to repay any outstanding amounts still owed.
Even though 403(b) accounts are individually owned, they are considered Employer Sponsored Plans and are therefore non-assignable and non-attachable. In the event a participant resides in a community property state, the participant's spouse is entitled to 50% of the account in the event of marital dissolution. In the event of a divorce, the court issues a domestic order and the account is divided into two parts as of the date of separation; each spouse owns a portion.
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Each owner of a 403(b) account can name beneficiaries to the account in the event of the death of the participant. If the participant is a resident of a community property state, the spouse must be named as the primary beneficiary to the account. The participant may name a person other than the spouse as the primary beneficiary, but only with the spouse's written consent. There can be more than one primary beneficiary to an account and the account will be divided per the participant's wishes. Secondary beneficiaries can also be named to receive the account in the event that the primary beneficiaries do not survive.
Spousal beneficiaries have the right to continue the account in its deferred state over their lifetime. Beneficiaries other than spousal are required to either distribute the entire account within five years of the death of the participant, or elect a lifetime income from the account by December 31st of the year following the death of the participant. Both primary and contingent beneficiaries have the right to transfer the account to another 403(b) or IRA account.
If the account is in distribution mode at the time of the participant's death and the beneficiary is acknowledged as being included as a joint life expectancy payee, payments can continue to the beneficiary as if they were being paid to the participant.
Variations are extensive and complex in this area. A good deal of thought should be exercised prior to naming a beneficiary or deciding how to structure a payments system including a beneficiary.
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