What Is the Difference Between a 403(b) & an IRA?

A 403(b) and an individual retirement arrangement are two types of retirement plans. A 403(b) is usually something set up through work for employees of certain government agencies and nonprofits, similar to a 401(k) offered at for-profit companies, while an IRA is usually something you set up for yourself. Both allow you to defer tax on money you put into the account until you withdraw it, usually at retirement age.

TL;DR (Too Long; Didn't Read)

A 403(b) is a retirement account set up through certain employers. An IRA is normally one you set up for yourself through a bank, brokerage or other financial institution.

Difference Between 403(b) and IRA

A 403(b) is a retirement account set up for certain nonprofit and government employees, especially workers in public schools. Like the 401(k) accounts common at for-profit workplaces, it's named for a section of the U.S. tax code where it is defined. It is also known as a tax-sheltered annuity plan.

One of the biggest differences is that you cannot set up a 403(b) plan for yourself. It must be set up by your employer. If you're a self-employed religious minister, your religious denomination must set up the plan for you.

Money in 403(b) plans also must be invested in either mutual funds or annuities offered through insurance companies. An annuity is an investment that pays off a certain rate of income over a period of time. Money in IRAs can be invested in a wider range of investments, depending on what's offered by the institution through which you set it up, though funds can't be invested in collectibles like art or precious gems.

Certain types of IRAs called Simplified Employee Pension, or SEP, and Savings Incentive Match Plan for Employees, or SIMPLE, are IRAs that are set up by employers for their employees. They function more like 403(b) or 401(k) plans than traditional IRAs.

403(b) vs. IRA

If you work for an employer that offers a 403(b) plan, you may be deciding how much to invest in your work plan versus any personal IRAs you have. There are a number of factors that might influence your decision about how to divvy up your retirement funds.

If your employer offers some matching of funds you contribute to your 403(b), that might be an incentive to invest more money there rather than in your IRA. Many employers will match a certain percentage of funds contributed to a retirement account in order to provide an incentive to save for retirement. Check with your employer to learn the details of what is or is not offered.

The range of funds available and fees they charge may also influence your decision about where to invest for retirement. Your employer or 403(b) plan administrator can usually provide you with this information, including documents about the various possibilities available. You can shop around for an IRA provider with the types of investments you want to pick if you're not satisfied with what's available through your 403(b) or any current IRAs you may already have opened.

There are annual contribution limits to both 403(b) and IRA plans, so you may wish to contribute some money to your personal IRA and some to your 403(b) to stay within these limits. The IRA limits are combined across all IRAs you may have, so you can't contribute more if you have IRAs at multiple providers, including both traditional and Roth IRA accounts.

Roth IRAs and 403(b) Accounts

Traditionally, when you put money into a 403(b) or IRA account, you don't pay tax on it until you withdraw it. This can help you immediately save on taxes and save in the long term if tax rates go down over time or your tax bracket goes down when you retire, which are both historically common scenarios.

The exception is accounts known as Roth accounts. With a Roth IRA or Roth 403(b), you pay tax on your income as you normally would and then place the after-tax money in the retirement account. When you withdraw it, you don't pay any tax on your withdrawals, including any investment gains you've made in the meantime. This can be a useful investment option if you expect you'll be paying a high tax rate even after retirement age.

Rolling Over Retirement Accounts

If you leave a job that offers a 403(b) account or 401(k) account, you can roll those funds into a rollover IRA with a provider of your choice. There's no tax penalty for doing so, provided you follow IRS rules when you make the rollover.

Generally, you can't remove funds from your 403(b) while you're employed unless you're at least 59 ½, disabled or called to active duty by the National Guard or the military reserves. You can't even transfer funds from a 403(b) or 401(k) to an IRA while you are still employed by that employer. If your employer switches 403(b) plan providers, you can usually transfer funds from one provider to the new one.

A 403(b) or 401(k) rollover to an IRA is generally relatively painless, but you should work with both account providers to make sure you won't take possession of the funds. You generally want the funds to be sent directly from one provider to another to avoid mandatory withholding taxes and additional penalties if you hold on to the funds for too long. Many companies will assist you in rolling over funds into their IRAs.

Withdrawing from Retirement Accounts

If you withdraw from a retirement account before you reach age 59 ½, you will generally face a 10 percent tax penalty. This can be waived in certain circumstances if you need the money for medical expenses or because the IRS is seizing the money for back taxes. Additionally, if you are in the military reserves or National Guard and you are called to active military duty, you can withdraw funds without penalty in certain circumstances.

There are more situations where you can waive the 10 percent penalty with an IRA than with an employee plan such as a 401(k) or 403(b). Specifically, first-time homebuyers may withdraw up to $10,000 with no tax penalty, people spending money on certain educational expenses can do so without penalty and unemployed people can take money from their IRAs to pay for health insurance. This can be a significant difference between a 403(b) and an IRA depending on your circumstances.

Because IRAs offer more opportunities to use funds before retirement age and allow for a greater range of investments, it can make sense to roll a 403(b) into an IRA when you leave a company that offers one.

Mandatory Distributions in Later Years

After you reach a certain age, you are legally required to begin withdrawing money from your retirement accounts, including 403(b) and IRA accounts. The rules for these so-called required minimum distributions are slightly different for each type of account and can be complex, so it's worth working with your plan manager, bank, brokerage or a tax adviser to make sure you're following the rules and don't incur a penalty.

Since withdrawing from a retirement plan counts as taxable income, you may wish to defer making withdrawals until you really need to do so. You may wish to defer withdrawals to years in which you'll have less income or simply take minimum distributions as long as possible.

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