Saving for retirement is essential to ensure that you have the financial means do what you want later in life. Many for-profit companies offer 401(k) retirement plans to their workers, but certain tax-exempt organizations like schools, hospitals and religious institutions offer 403(b) plans, which have many of the same advantages and disadvantages as 401(k) plans.
The biggest advantage of using a 403(b) plan to save for retirement is that contributions are made on a pre-tax basis. In other words, the money you put into a 403(b) plan avoids taxation in the year that you put the funds into your account. You don't have to pay taxes on your contributions until you withdraw them after age 59 1/2. Since your income is likely to be lower during retirement than it is during your working life, the amount of tax you pay on 403(b) withdrawals may be less than your current income tax rate.
The purpose of a retirement account is to provide a place to make investments and build wealth for the long term. When you invest in assets like stocks and mutual funds, you can earn profits called capital gains if you sell shares at prices that are higher than their original price. Your stocks may also pay you a share of the company's profit for the year, known as a dividend. The government normally imposes capital gains taxes on profits derived from investments along with taxes on dividends, but you don't have to pay taxes on investment gains or dividends in a 403(b) plan until you take your money out. Deferred taxes on gains can increase long-term investment growth and leave you with more money in your account when you eventually retire. On the downside, keep in mind that the current tax rate, as of 2012, on long-term capital gains and most stock dividends is capped at 15 percent -- a rate that is much lower than the maximum income tax rate that most wage earners pay. Also, capital gains are only paid on the gain on a stock if the stock is held in a non-retirement account, whereas the entire value of the investment will be taxed as income on withdrawal if the stock is bought inside a qualified retirement account.
One of the main disadvantages of 403(b) plans is that the government penalizes you if you take your money out too soon. According to the IRS, 403(b) accounts are subject to a 10 percent early withdrawal tax penalty if you withdraw funds before the age of 59 1/2. This penalty also applies to 401(k) accounts and individual retirement arrangements, or IRAs.
Another disadvantage of 403(b) plans is that the government forces you to withdraw or "distribute" funds during retirement. The IRS states that you have to start taking "required minimum distributions" starting at the age of 70 1/2 or the age at which you retire if you retire after age 70 1/2. Failure to make a minimum withdrawal results in a 50-percent tax penalty on the amount that you were required to withdraw.
- IRS: 403(b) Plan Basics
- CNN Money: What's a 403(b) Plan?
- CNN Money: How Much Can I Contribute to a 403(b)?
- CNN Money: How is a 403(b) Different From a 401(k)?
- IRS: Retirement Plans FAQs regarding Required Minimum Distributions
- IRS: Topic 558 - Tax on Early Distributions from Retirement Plans, Other Than IRAs