A 403(b) plan is an employer-sponsored retirement plan for certain employees of public schools, tax-exempt (501(c)(3)) organizations, and churches.

The employer can purchase annuity contracts for eligible employees, or establish custodial accounts to be invested in mutual funds or other investments. In the case of annuity contracts, a 403(b) plan is sometimes referred to as a tax-sheltered annuity (TSA) plan. (Church plans are subject to several special rules not covered here.)

How Does the Plan Work

Depending on the specific type of 403(b) plan, contributions may be made by the employee, the employer, or both the employee and employer. Many 403(b) plans are similar to 401(k) plans: you elect either to receive cash payments (wages) from your employer immediately, or to defer receipt of all or part of that income to your 403(b) account. The amount you defer (called an “elective deferral”) can be either pretax or, if your plan permits, after-tax Roth contributions.

Employer contributions, if made, may be a fixed percentage of your compensation, or may match a specified percentage of your contribution, or may be discretionary on the part of the employer. One unique characteristic of 403(b) plans is that your employer is allowed to make contributions to your account for up to five years after you terminate employment.

What Are the Contribution Limits

You can defer up to $17,000 of your pay to a 403(b) plan in 2012. If your plan allows Roth contributions, you can split your contribution between pretax and Roth contributions any way you wish. Unlike 401(k) plans, employee elective deferrals to 403(b) plans aren’t subject to discrimination testing (which in 401(k) plans can often significantly limit the amount higher-paid employees can defer).

If your plan permits, you may also be able to make “catch-up” contributions to your account. You can contribute up to an additional $5,500 in 2012 if you’ll be age 50 or older by the end of the year. If you have 15 years of service with your employer (even if you haven’t attained age 50) a special Section 403(b) rule may also allow you to make annual catch-up contributions of $3,000, up to $15,000 lifetime. If you’re eligible for both rules, then any catch-up contributions you make count first against your 15-year $15,000 lifetime limit.

When Can I Access My Money

In general, you can’t withdraw your elective deferrals from your 403(b) until you reach age 59½, become disabled, or terminate employment (deferrals to annuity contracts prior to 1989 aren’t subject to these restrictions). Some plans allow you to make a withdrawal if you have an immediate and heavy financial need (“hardship”), but this should be a last resort–not only is a hardship distribution a taxable event, but you may be suspended from plan participation for six months or more. If your plan allows after-tax (non-Roth) contributions, your plan can let you withdraw these dollars at any time.

Employer contributions to 403(b) custodial accounts are subject to similar withdrawal restrictions. But employer contributions and pre-1989 deferrals to 403(b) annuity contracts are subject to somewhat more lenient distribution rules. Check with your plan administrator for your plan’s specific rules.

If your plan permits loans, you may be able to borrow up to one-half of your vested 403(b) account balance (to a maximum of $50,000) if you need the money.

What Happens When I Terminate Employment

Generally, you forfeit all employer contributions that haven’t vested. “Vesting” means that you own the contributions. Your plan may require up to six years of service before you’re fully vested in employer contributions, although some plans have much faster vesting schedules. (Your own contributions are always 100% vested.) You can generally leave your money in your 403(b) account, transfer it to a new 403(b) account, roll your dollars over to an IRA or to another employer’s retirement plan, or take a distribution.

Contact us today for a financial review.  Manuel A. Martinez is a CERTIFIED FINANCIAL PLANNER™ focused on helping families and small businesses in the Charleston South Carolina area. The following information is reprinted with permission from Forefield, Inc. Copyright 2006-2012.