Named after the piece of the tax code that created them, 403(b) plans allow workers to contribute part of their wages to a personal retirement account. In 2008, workers can save up to $15,500, or, if they're over 50, up to $20,500. In 2009, workers can save up to $16,500, or up to $22,000 if they're over 50.
Employees who have worked for the non-profit organization for 15 years or more generally can contribute $3,000 a year more. The contributions are tax-free in the year in which they are made, and they grow tax-deferred until the money is withdrawn.
Some plans also offer a Roth 403(b) option, in which employee contributions are taxed, but all growth and withdrawals are tax-exempt -- which can be an excellent way to generate tax-free retirement income.
Most withdrawals from a 403(b) plan taken before age 59 1/2 face a 10% penalty plus income tax.
Types of 403(b) Plans
The term tax sheltered annuity, or TSA, has become a synonym for 403(b)s because before the laws changed in 1974, all 403(b) participants invested in annuities -- insurance products that resemble investment accounts. Today, many 403(b) plans offer employees a wide range of investments, including mutual funds that invest in stocks and bonds. Some, however, still use annuities.
Expenses are the key difference.
Although annuities can offer investors everything from a fixed-rate of return to a mix of managed stock and bond investments, they also tend to come with insurance products attached, like guarantees of minimum payouts to an account -holder's heirs. Most also offer the option of a guaranteed income for life after retirement, at a level that depends on the size of the account.
Annuities tend to be more expensive to maintain than mutual funds, largely due to the insurance components. And many also charge hefty penalties -- as much as 7% in the early years of the investment -- for early cash-outs, even if they are done as part of a rollover .
Advantages of 403(b) Plans
Although the higher expenses of an annuity are a drag on overall returns in the long run, all 403(b) plans do have some advantages over other types of retirement plans. Employees, for instance, generally can start participating earlier in their careers because 403(b)s are required to be available to full-time employees, with very few exceptions, regardless of their length of service.
For retirement planning, that is a crucial point. The money you invest in the earliest years of employment has the most time to grow before you tap into it. And because the growth is tax-free until you cash out, early investment dollars in a 403(b) are some of the most turbo-charged dollars you will ever invest.