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You may have heard the term 403b briefly in HR orientation. Or, perhaps when a salesman threw a pitch at you in the lunchroom (ugh…so annoying!) You probably ignored it or wrote it off as too confusing. Now, you’re interested in investing for retirement and want to actually understand the 403 b. I’m here!
As with many things involving retirement investing, the 403b landscape is almost intentionally confusing. People are more familiar with the concept of a 401k – a 403b is like that with a few very important differences. After reading this, I hope you’ll know what a 403b is, how to use it, and what to watch out for.
After you’ve learned more about a 403b, don’t forget to read: 403(b) vs. 457(b): Which Should I Choose?
What Is A 403b?
A 403b, or more correctly a 403 (b), is a retirement saving option available to employees of public and non-profit organizations.
The name 403 (b) comes from the related tax code. You’ll also often hear a 403b referred to as a TSA or a “tax sheltered annuity.” This is a holdover from the past. Again – this is all far more confusing than it should be.
A 403b is a retirement contribution option available to almost all public educators. Your employer has to offer a 403b plan (most school districts do) for you to enroll. You contribute to the plan directly from your paycheck.
The good news is that you contribute pre-tax. That means you don’t pay any tax on the amount you invest in your 403b. This is a big advantage, especially as your salary goes up over the course of your career. Your investment also grows tax free. Over time, this can amount to a huge savings.
You pay taxes when you withdraw the money – usually during retirement when your taxable income is likely lower.
This should be a great deal for educators and the cornerstone of an educator’s financial plans. Unfortunately, this isn’t universally true. Too many of our colleagues need to be wary of their 403b plans.
What Should I Watch Out For?
Sadly, I have to share warnings early in this overview. A 403(b) option isn’t always a clear win.
School districts have a responsibility to look out for the well-being of their staff. Unfortunately, many don’t. Neither does the government – the rules and regulations that help protect retirement plans don’t always apply to 403b plans. As a result, educators must watch out for several hazards in 403b world.
Many school districts cut deals with companies that allow salespeople into schools. Sometimes, districts expressly forbid this and salespeople show up anyway.
Either way, there is nothing worse than predatory sales people stalking hallways and lunchrooms and pressuring people to “invest” with them.
It’s a pretty good bet that if they are using aggressive sales tactics then it is something you should avoid. Generally, they are trying to get you to buy insurance products. Which brings us to the next challenge with 403b…
Remember, you can only invest in a 403b through your employer. That means you are limited in what products you can select.
Far too many districts only offer insurance products and/or annuities. I believe that all educators should have access to at least one low-fee passively managed index fund. Unfortunately, many do not. Instead they have access to insurance products, annuities, and actively managed funds. All of these typically underperform AND cost more to own.
Even districts that do offer index funds from reputable vendors (think Vanguard, Fidelity, Schwab) often obscure these funds by offering a variety of complex products. This is often disguised as empowering choice, when in reality it introduces unnecessary complexity.
This can result in educators choosing a bad product or walking away entirely in confusion.
Read Two Steaming Piles of 403B.S to see how insurance companies actively push this approach.
Of course, the worst part of all this is that many educators end up in products with outrageous fees. Higher fees can cost you tens of thousands of dollars (or more) over the course of your career. I consider anything above .5% high and it is not uncommon for educators to look at total fee loads of 2% or more in 403b offerings. If these are the only products available to you, it’s best to invest in your IRA, 457b, or even a standard brokerage account.
When Should You Use a 403b?
Did the previous section discourage you from using your 403b? Just like you can’t assume that all 403b are good, please don’t assume that all are bad. In fact, 403b make sense for many educators!
Take the time to examine your options.
You can usually find 403b plan information on your district website. If not, googling *your district* + “403b” will work most of the time. You’ll often be directed to plan providers for more details or product sheets.
While every investment decision is personal, I look for low-cost passively managed funds, preferably from the three brokers I mentioned before: Vanguard, Fidelity, Schwab. These vendors have a track record of reasonable fees and solid options.
I instinctively avoid any insurance company. (If you have an example of an insurance company with a good 403b option I’d love to see it.)
I’m fortunate to have Vanguard as an option in my 403b. I choose to invest in VTSAX. (Vanguard Total Stock Market Index fund.)
How Do You Use a 403b?
Okay, so you’ve identified an option that works for you. What next?
Enroll Through Your Employer
Unlike an IRA or a brokerage account, you have to contribute to a 403b through your employer. Again, your district website should have enrollment information. Typically, you’ll need to register with your 403b plan provider. The steps will vary by district and provider but aren’t too onerous.
Select an Option
Select your investment option, or options. You can always change this later. Again, I typically look for a passively managed index fund.
Many providers now offer a target date retirement fund which builds in some diversification and changes asset allocation over time. These are reasonable selections if the fee is still relatively low.
(For comparison – the Vanguard Total Stock Market Index fund has an expense ratio of .04%. The target date retirement options have expense ratios of .15%. Both are reasonable.)
Every investment decision is personal to your goals. That said, don’t let this paralyze you and keep you from investing. If you have access to index funds or target date funds, start now.
Contribute Directly From Your Paycheck
You’ll need to set up contributions through your payroll office. Again, your district website or payroll office is your friend. Someone will be able to help you set-up the payroll contribution. Check to ensure it is applied correctly on your next paycheck.
You can change the amount you contribute. Get it started and adjust as needed. (I recommend upping your contribution each year when you get your annual raise.)
Option – Roll Over If You Change Employers
I won’t get too deeply into this, but did want to address it. Unlike pensions, your 403b is not tied directly to your employer. If you change employers you can choose to roll the 403b to your new employer, leave it with your current employer, or make any of several other moves.
Your 403b contributions are yours and do not have a vesting period. For simplicity, I have rolled previous 403b accounts into my current account with Vanguard. The process was simple.
How Much Can You Contribute?
Great – you’re using a 403b now! Unfortunately, you can’t make unlimited contributions.
Annual Elective Limit
The allowable contribution for 403b users is the same as for a 401k.
In 2019, you are allowed to make an elective contribution of up to $19000. To contribute the full $19000, you have to earn at least that much. (Remember – 403b contributions are made through payroll.)
The annual limit applies even if you switch employers mid-year.
Catch Up Provisions
You may have the option to utilize catch-up provisions. These provisions are designed to allow later career educators to contribute more to their retirement.
If you are 50 or older, you are eligible to contribute an additional $6000 to your 403b, for a total of $25000 in 2019.
15 Years With Current Employer
If you have 15 years or more of service with your current organization, you may be eligible for this catch-up provision regardless of age. It allows up to $3000 a year additional contribution if you haven’t used it in prior years.
Not all employers allow this option. If you are interested in using it, confirm both your eligibility and availability.
As an example, TFI has been with her current district for 20 years. We discovered this last year, and she is now contributing a total of $22000 to her 403b this year.
The interaction of the catch-up provisions can get complex. If you are eligible for both, I’d suggest reviewing the IRS guidance on contribution limits.
Employer Contributions and Cumulative Total
In addition to your own elective deferrals, your employer can contribute to your 403b as well. Unfortunately, this is rare in education but is available to some.
The total cumulative contribution between employer and employee elective deferral is $56,000 for 2019.
If you are contributing the full $19000, that means your employer could contribute $37000 on your behalf. I’m not aware of any education contributions that high – but if this is you congratulations!
Note: Contribution limits are per person, not per family. If you are a two educator household, you can double those contributions! TFI and I are contributing a total of $41,000 per year. $19000 for each of us and she is eligible for the 15-years catch-up provision. That’s $41,000 going to retirement pre-tax!
|2019 403(b) LIMITS|
|Catch-up: Age 50+||$6000|
|Catch-up: 15 Years w/ Employer||$3000|
|Total Employee Plus Employer||$56,000|
403b: A Useful Tool Under the Right Circumstances
There you have it – my quick overview of the 403b. These are the things I wish I’d known earlier in my career. Fortunately, I wasn’t suckered by the salesman into bad products, but by not investing at all I wasted 10 years of potential gains.
Once I finally started, I had to research on my own to grow my understanding. I hope this overview has been helpful to you.
If you have any questions, do not hesitate to contact me. I’m here to help you do better than I’ve done.
Other 403b Resources
If you are interested in learning more about 403b, here are several other helpful resources:
- A Teacher’s Guide to 403b
- Pros and Cons of 403b
- IRS Publication 571 (01/2019), Tax-Sheltered Annuity Plans (403(b) Plans
Other Investment Options to Explore
Here are other possible tools for growing your wealth if your 403b options are sub-par or you simply want to understand all the options available to you: