A 403b plan is a form supplemental savings available to teachers in the U.S.
How much income do you need in retirement to have a comfortable life? The answer to this question varies from person to person depending on their needs and preferences. But, for most people, the retirement plan provided by their employer alone will not be enough. That’s where supplemental retirement savings comes in.
This article will cover some of the key features of 403b teacher plans. We’ll discuss how they differ from other retirement plans along with some pros and cons.
It is important to note that Equable is not a financial advisor. We don’t sell retirement services, nor are we official retirement planners. The information in this article is intended to be educational content. You should discuss any specific questions about your own retirement planning with a financial advisor.
What is a 403b retirement plan for teachers?
A 403b supplemental plan is a type of defined contribution retirement plan. It is an individual retirement account where employees contribute money on a pre-tax basis.
As of the 2022 tax year, teachers can divert as much as $20,500 of their salaries into a 403b plan. This is usually diverted as a percentage of each paycheck while you are still working. This money is then invested based on individual preference and risk tolerance. The account holder pays taxes only when they withdraw the money in retirement.
If an individual wants to save beyond the tax-free limit, they can do so into a Roth 403b plan.
In some cases, a school district might also contribute to a 403b plan. But, districts usually only contribute to 403b plans that are your primary source of retirement income. In most cases, 403b plans for teachers are supplemental retirement savings.
What you need to know about supplemental teacher retirement plans
The “supplemental” aspect of 403b plans is important to keep in mind.
For most teachers, a primary retirement plan is usually a pension. But they may also come in the form of a guaranteed return, defined contribution, or hybrid plan. Most primary teacher retirement plans are not designed to provide the employee’s only source of retirement income.
Many state pension plans assume that a teacher will also have Social Security, and/or some source of personal retirement savings. As a result, most individuals enrolled in a pension plan will not wind up with adequate retirement savings from that pension.
Teachers may also move around and don’t often accumulate a full career of teaching in a single state. This reduces the total net pension benefits earned over the course of their career.
Supplemental savings can be an important tool for ensuring an adequate level of retirement income.
There are dozens of financial firms that sell 403b services. Many of them are predatory and sell retirement plans that charge high fee to invest money. But some of the services offered are reasonable can can support retirement savings. (403b Wise graded different financial companies offering supplemental plans for teachers in their “district plan rating project”).
A few states have created statewide systems for offering 403b plans to teachers and other public workers. In most states, districts manage the availability of supplemental retirement savings.
A common problem with 403b plans is that financial firms will try to lock teachers into a plan that charges fees if the teacher pulls their money out (a “surrender charge”). Other problematic 403b plans only include investment options that charge high management fees.
Some of the best employer practices for avoiding these problems include:
- hiring an independent advisor to select the investment options that are made available to teachers. This ensures that 403b investments have reasonable and transparent costs;
- limiting the total number of financial firms who can offer services. This forces investment vendors to compete with each other and offer the lowest management prices;
- requiring a regular process of bidding by financial firms to ensure there is regular, quality competition.
The money in a 403b plan is generally withdrawn based on IRS rules for using the money as retirement income. Typically, this means you can withdraw funds starting at 59 1/2 years old.
A 10% penalty is typically applied to money withdrawn before then, but there are hardship exemptions. There is also a point where individuals must withdraw a minimum amount of money from the 403b plan yearly. The remaining funds can continue to accumulate investment returns.
Find your state’s teacher retirement plan at RetirementSecurity.Report to find out if your plan provides adequate income before supplemental savings.
What is the difference between 403b, 401k, and 457 Plans?
There are many different kinds of retirement savings accounts. The United States tax code has set up special taxation rules for these accounts, which lead to different designations such as 401k or 457.
For the most part, however, there isn’t a big difference between 401k, 403b, and 457 plans when it comes to how an individual can save for retirement. All three allow employees to contribute money on a pre-tax basis. The maximum contribution into 401k and 403b plans for those who are over 50 years old is larger than 457 plans.
The main difference between 401k and 403b plans is who offers them. Generally, the private sector and for-profit companies offer 401k defined contribution plans. Government organizations and non-profit organizations offer 403b plans. (For example, Equable Institute is a non-profit, so we offer our employees a 403b plan.)
The main difference between a 403b and 457 plan is the pre-tax contribution limit for those over 50 years old. As of 2022, the maximum annual contribution into both types of plans is $20,500. However, individuals over 50 years old can contribute up to $61,000 a year into a 403b plan. The same so-called “catch-up” provision isn’t available for 457 plans.
The Pros and Cons of 403b Plans
There are various ways to offer retirement benefits, with different benefits and drawbacks. Here is how supplemental 403b plans stack up depending on the objectives for offering retirement benefits in the first place.
- Adequate Retirement Income Security
- Pro: 403b plans can support retirement income adequacy by providing an additional source of income. This is important for the majority of teachers who won’t work long enough in a single state to earn a full pension
- Con: 403b plans can sometimes be offered by predatory financial companies who charge high fees and lock up money invested with them.
This may be a negative contributor to adequate retirement income security.
- Funding and Budgetary Predictability
- There is 100% budgetary predictability for school district employers with 403b plans. Employers don’t usually contribute to supplemental 403b plans, so it doesn’t complicate budgeting.
- Choosing to offer (or not offer) a supplemental retirement plan likely does not impact teacher retention.
- Employee Career Mobility/Portability
- Pro: As an individual retirement account, 403b plans are usually portable between employers. This means if a teacher moves to another job or state, they can roll over the funds in their 403b plan to another individual retirement account.