403(b) Retirement Accounts

Take-Away: An IRC 403(b) account is very similar to an IRC 401(k) account. One exception, however, is the opportunity to contribute a bit more as a ‘catch-up’ contribution to an IRC 403(b) account.

Background: While the 403(b) account is close to a 401(k) account there are a few important distinctions between the two. You can even have a Roth 403(b) account. The contribution limitations for a 403(b) account are normally the same as for an IRC 401(k) account: in 2018, a maximum $18,500 contribution is permitted with an additional $6,000 if the account owner is over the age of 50 years. Like a 401(k) account, withdrawals from a 403(b) account prior to age 59 ½ will trigger the 10% early withdrawal penalty.

Distinguishing Characteristics:

Participants: 403(b) plans are only available to ministers, employees of nonprofit organizations, public school employees, and employees of certain types of hospitals.
Administrative Costs: A general perception (true or not) is that the administrative costs normally associated with a 403(b) plan are somewhat lower.
Vesting: Often with a 403(b) plan the vesting period is much shorter than it is with a 401(k) plan. Some 403(b) plans permit 100% immediate vesting of the employer’s matching contribution.
Matching Contributions: While it is possible for the employer to match participant contributions to a 403(b) plan consistent with those employer matching contributions to 401(k) plans, often the matching contribution rate of the plan sponsor is lower. A common matching contribution rate for the sponsor of a 403(b) plan is 50 cents on the dollar for participant contributions up to 3% to 5% of the participant’s compensation.

Biggest Distinction- Additional Contribution: Probably the largest distinction between a 401(k) account and a 403(b) account is that it may be possible to make yet another ‘catch-up’ contribution to the 403(b) account, an opportunity that is not available to an individual who maintains a 401(k) account. Some 403(b) plans permit an individual participant with 15 or more years of service to make an additional contribution to the 403(b) account. The formula used for this additional contribution is a bit confusing.

Formula: The amount of this additional ‘catch-up’ contribution by an employee to their 403(b) account is the lesser of:

$3,000; or
$15,000 reduced by the amount of additional elective deferrals made in prior years because of this rule; or
$5,000 times the number of the employee’s years of service minus the total elective deferrals made for earlier years.

Example #1: The employee has contributed $13,000 to their 403(b) account in previous years using this special rule. That means that the employee could contribute another $2,000 this year, because this ‘catch-up’ rule limits these ‘extra’ contributions to a maximum of $15,000.

Example #2: Assume that the employee has worked for the plan sponsor for 15 years. In that case the employee multiplies $5,000 by 15 for a total of $75,000. Then, the employee subtracts the total that the employee has contributed to his/her 403(b) account [ignoring any employer matching contributions.] That leaves the employee with his remaining maximum ‘catch-up’ contribution. If the employee has $73,500 already in his/her 403(b) account, he/she can only contribute an extra $1,500 under the 15+ years of service rule.

Stacking: This special ‘catch-up’ contribution can be stacked. If the employee is over age 50 years and has 15 years of service, the employee could contribute up to $27,500 in 2018: $18,500 standard contribution, + 403(b) contribution maximum + $3,000 for the 15 years of service special ‘catch-up’ contribution, + $6,000 standard maximum ‘catch up’ contribution.

Conclusion: Generally the IRC 403(b) is much like a 401(k) account with only a few minor difference, probably the most important is the type of participant who can open one.