26 Oct University of New Mexico Faculty and Staff | Are you maximizing the benefits of your 403(b) retirement program?
What is the 403(b) retirement program?
A 403(b) plan is a type of tax sheltered retirement plan which has a lot in common with the more widely recognized 401(k) plans. A 403(b) plan is for employees who work in organizations that serve educational and non-profit purposes. These plans accept payroll-deducted contributions for participant-directed investing and are intended to help employees meet long-term objectives, such as generating retirement income. This plan is in addition to the mandatory retirement programs (Educational Retirement Board or Alternative Retirement Plan) offered by UNM. The 403(b) plan is categorized as a supplemental retirement plan. https://hr.unm.edu/retirement.
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How does the 403(b) plan work?
As a 403(b) plan participant, you contribute salary reductions – or “deferrals” – which are placed in a participant-directed investment account. Contributions are limited to an annual maximum dollar amount, as established under the IRC. For 2016, the annual salary contribution limit is $18,000. If you over age 50, you can make a catch up contribution of $6,000 for a total of $24,000.
Once in your account, you decide where you want to invest your contributions from options selected by your employer, the plan sponsor. These options are offered by different investment companies such as Fidelity and TIAA-CREF. Investing involves market risk, including possible loss of principal. This is where many employees struggle. We have the resources and experience to maximize the investments for your particular situation.
What are the advantages of participating in a 403(b) plan?
- Contributions to a traditional 403(b) plan are tax deductible.
Contributions to a traditional 403(b) plan are deductible for federal income tax In effect, money is placed into the 403(b) plan without having to pay any taxes on it. The tax deduction can be highly valuable since it reduces the amount of income tax paid at the individual’s marginal tax bracket. For example, if the last $10,000 of a worker’s adjusted gross income were be taxed in the 25% tax bracket, putting that $10,000 into a traditional 403(b) would net a tax savings of $2,500.
- Taxes are paid on distributions in retirement. A time when many people are in a lower tax bracket. If you make traditional pretax contributions, you will have to pay taxes on distributions in retirement. The good news is that most people are in a lower tax bracket when they retire, and most retirees require less income than at their peak earning years. Many retirees have already paid off their houses and cars, and their kids are out of the house and through college. In addition, retirees don’t have to pay for many work-related expenses such as a professional wardrobe and commuting costs.
- Savings grow tax-free. A huge advantage of a 403(b) plan is that you do not have to pay taxes on dividends, interest and capital gains on your investments held in the 403(b) account. If you hold your retirement investments in a normal taxable brokerage account, you will lose a lot of potential earnings due to the significant drag that taxes can impose. Since you don’t have to worry about tax effects in your 403(b), you can rebalance your portfolio more often. You also don’t have to worry about the tax efficiency of any mutual funds you hold, allowing you a free hand to focus purely on high returns and low expenses.
- Loans can be taken against a 403(b) plan. Although it depends on the specific provisions of your 403(b) plan, most people will find they are allowed to take a loan out of their 403(b) plans. This can be a big help in certain situations, such as buying a home. If you choose to use this benefit, you must make sure you understand all of the consequences. Many advisors warn against this idea because it leaves less money in the 403(b) plan invested for your retirement. Therefore, you must make sure you have enough saved that you can afford to withdraw the loan
As you can see, there are many things to like about 403(b) plans. To best capitalize on these benefits, the key is to contribute early and frequently. Often it is possible to arrange with your payroll department to have a small percentage deposited in a 403(b) directly from your paycheck so you don’t even notice it. It is sometimes difficult to get started, especially if retirement is still far off. However, even relatively small contributions made consistently over time have a way of adding up. In addition, if you have maxed out contributions, you may also qualify for a 457(b) plan. This plan is similar to the 403(b), however it can allow for even greater retirement savings.
Sources: Investopedia.com, IRS.gov
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