A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
It’s similar to a 401(k) plan but has a few differences.
What is the difference between a 403(b) and a 401(k)?
A 403(b) is used by nonprofit companies, religious groups, school districts, and governmental organizations. The law allows these organizations to be exempt from certain administrative processes that apply to 401(k) plans. In other words, administrative costs for a 403(b) are lower. This allows organizations with very small budgets to help their employees save for retirement.
What is the difference between a 403(b) and a pension plan?
No. The structure of these two financial products are very different.
Pension Plans
A pension plan relies on the employer to provide employee benefits. Contributions to a pension plan are made solely by employers. Employees have no say over how much is invested. The Company has complete authority over investment decisions with those funds. However, since a pension plan promises to make certain payments to employees when they retire, they typically invest in conservative, low-cost investments.
Most traditional pension plans start to pay out when you reach age 65. Some plans allow distributions earlier, when you have reached age 55 with certain provisions, such as having worked at the company for at least 10 years. However, if you take your pension distribution early, you’ll likely receive a smaller monthly payout than if you had waited until you reached the full retirement age.
The problem with some pension plans, all over the world, is that they are underfunded. Poor management and near zero interest rates have severely hurt investment yields.
Many pension funds are made up entirely of government bonds. Quantitative easing by the Central Banks pushed interest rates downward to record low rates and this had an adverse affect on pension balances. Most pension funds based their funding projections on achieving an annual investment return of 8%. This did not happen; and now, pension funds are severely underfunded.
403(b)
A 403(b) offers employees more control over the contributions and performance. Employees can elect to have a portion of their paycheck withheld and deposited directly into the plan before they are taxed. You bear the responsibility for how you invest your money. A typical 403(b) plan will offer an assortment of mutual funds and annuities that you can invest in based on your risk tolerance. The amount of money you have available at retirement is based on how well your funds perform. This can either be good or bad. With a 403(b), there is no guarantee, from your employer or from any government agency, of receiving any money from your 403(b) retirement plan.
With a 403(b), you usually cannot take money out until after you reach the age of 59 1/2 or in the event of your death or disability. If you leave your job, you are allowed to rollover your money into another tax-advantaged plan, such as an IRA. Some plans allow for hardship distribution, defined by the IRS as a “heavy and immediate financial need.”
Conclusion
If your company offers a 403(b) plan you should definitely invest in it. As with 401(k) plans, your contributions are invested on a pre-tax basis.