Retirement might seem a way long off, but the sooner you start to save the more likely you are to have a comfortable standard of living when you reach your golden years. Many employers sponsor retirement accounts. These plans come in many different shapes and sizes. 401k and 403b plans are among the most widely used. It helps to understand the difference between these plans if you work as a teacher or for a non profit group.
Employers of all sizes sponsor 401k plans. In many instances you can start contributing to the plan form the day you start your job. In contrast, 403b plans are only accessible to school employers, people working for certain tax-exempt entities, and certain ministers such as those employed as prison chaplains. 401k and 403b plans are both used by employers use to attract employees. However, neither state nor federal laws require your employer to offer any kind of retirement plan.
You are responsible for funding your own 401k plan. You do so by having part of your pre-tax income deducted from your net pay to go into the plan. Some plans also for after-tax employee contributions. Your employer might elect to make a matching contribution on your behalf. Employee contributions become vested over the course of up to five years. This means the money gradually becomes yours over that time period.
Contributions for 403b plans work in the same way with, the onus falling on you to contribute to the plan and your employer having the option to make matching contributions on your behalf. You can make after-tax contributions into a Roth 403b as well as make standard pre-tax contributions to the plan.
Under federal tax rules, 403b plan administrators can either invest your money into an annuity or a mutual fund. Annuities are life insurance products designed to provide you with an eventual monthly income benefit. Mutual funds are portfolios of investments containing securities such as stocks and bonds.
401k investment elections vary between companies. Your employer ultimately decides what to include in the plan. As a general rule, firms let you invest in a number of different mutual funds, although some companies also offer cash account options such as certificates of deposit for conservative investors.
When you withdraw money from a 401k or 403b plan, you must pay ordinary income tax on any funds that have not previously been taxed. If you made after-tax contributions to the account then you have to pay tax on all of the funds you receive. if you cash in your account before you reach the age of 59 1/2 you also pay a 10 percent federal tax penalty. The Internal Revenue Service waives the 10 percent penalty in some instances. such as if you become permanently disabled. Additionally, insurance firms sometimes assess penalties on premature withdrawals from annuities. You must pay these fees in addition to the taxes.
If you decide to quit your job and move to the private sector, then from a federal tax perspective you can roll 403b account proceeds into a 401k plan. You can also move funds into an Individual Retirement Account. However, while the Internal Revenue Service lets you make the switch, the plan administrator might have other ideas. In many instances, group annuity plans are set up to convert your funds into an income stream at some point in the future. If you leave your job, no further contributions are added. But the only way you can receive your money is in the form of monthly income checks when you retire. If your 403b contains mutual funds, you can more easily make the switch, although some firms do not allow you to roll money in from retirement accounts held with other companies.