Published Wednesday, February 1, 2017 at: 7:00 AM EST
If you work for a nonprofit organization—a hospital, school, or government agency, among many other kinds of groups—you can't participate in a 401(k) plan as a way to save for retirement. But not to worry: Many nonprofit employers offer 403(b) plans, which closely resemble 401(k)s and also can help you put away pre-tax dollars to fund your life after work.
Although there are a few important differences between the two kinds of plans, 403(b)s are quite similar to 401(k)s. You contribute to a 403(b) plan account on a pre-tax basis through salary deductions, just as you would fund a 401(k). Your contributions are invested and can grow and compound without being eroded by current taxes. Distributions generally are taxed at ordinary income rates.
Some organizations that offer 403(b)s also may give you the option of contributing to a Roth-type account that uses after-tax dollars for contributions but provides tax-free distributions during retirement.
The IRS limit on annual contributions to a 403(b) is the same as for 401(k) plans, and also is indexed for inflation. In 2017, you can contribute up to $18,000, plus another $6,000 if you're age 50 or over, for an annual maximum of $24,000. But there's an extra wrinkle for 403(b) plan participants. If you have worked for the same nonprofit for at least 15 years, you also can contribute up to an additional $3,000 a year—beyond the normal limits—for five years if your previous contributions have averaged less than $5,000 per year. That perk for 403(b) plans is unique and not available to participants in 401(k) plans.
Employers also may make contributions to 403(b) accounts, just as many companies provide matching contributions to 401(k)s.
One drawback of 403(b) plans has been a tendency to offer fewer investment choices than you would have in a 401(k) plan sponsored by a corporation. But that disparity is changing, and most 403(b) plans today allow you to choose from a wider variety of mutual funds, ranging from conservative to aggressive.
As in a 401(k) plan, if you make a withdrawal from a 403(b) plan before age 59½, it generally is subject to a 10% tax penalty, in addition to any regular tax owed. And in both kinds of plans, you must begin required minimum distributions after age 70½.
What happens if you quit, change jobs, or retire? Depending on your situation, you may roll over the funds in your 403(b) plan to a 403(b) or 401(k) at your new job, or to an IRA. Or you could decide to take a cash distribution, which will be taxable and could be subject to the 10% penalty tax for early withdrawals.
This article was written by a professional financial journalist for Advisor Products and is not intended as legal or investment advice.