Understanding 403(b) Retirement Plans For Churches, Non-Profits And Schools

If you’re a non-profit worker, chances are you are offered 403(b) plan to save for retirement. However, most retirement content focuses on more common 401(k) plans that most corporations offer. Though 403(b) plans are similar in some ways and serve the same basic purpose, it’s important to be aware of what makes 403(b) plans unique.

Tax Deferred Saving

Probably the best thing about a 403(b) plan is that it’s a tax-deferred way to save for retirement. You can typically save into your 403(b) plan tax free. That’s in contrast to the remainder of your income, which is potentially subject to income tax. When your money is sheltered from tax you keep more of it and it can grow faster.

The money in your 403(b) can generally grow tax-free until retirement. Once in retirement, you may have to pay tax on the money that you withdraw from your 403(b) plan. Still, there’s a decent chance you’ll be in a lower tax-bracket in retirement and of course you’ll have benefited from your money growing tax-free up to that point.

Many people like this set up, it’s worth noting that if you think income tax rates will rise dramatically between now and retirement or your own income tax is very low now compared to retirement, then a 403(b) plan may be less attractive for you. Still, there’s not too much of a catch here. The government wants people to save for retirement and have set up 403(b) plans to encourage it.

403(b) Plan Quality Varies

Unfortunately the quality of 403(b) plans does vary. The best plans contain a range of low-cost Exchange Traded Funds (ETFs). These mean that you can build a portfolio that meets your needs or simply hold a l0w-cost target date fund that handles the portfolio construction for you.

Generally, you want your ETFs to have fees of under 0.5% and hopefully under 0.2% for mainstream asset classes. The majority of ETFs just track an index, which doesn’t require any skill and so you shouldn’t overpay as performance isn’t likely to improve, in fact it will probably worsen as higher fees just eat into your savings according to most academic studies.

However, less attractive 403(b) can contain things like annuities and insurance. Unfortunately, these can be a better deal for the person selling you the product than your retirement prospects. If these products are on offer, you may want to be cautious. Better investment products generally don’t involve a salesperson, so if a salesperson is involved, that’s a red flag.

ERISA

Another important thing to check is if your 403(b) plan is covered by ERISA (Employee Retirement Income Security Act of 1974) if so that’s probably good news. ERISA is a set of basic standards set by the Department of Labor that mean the plan is more likely to be managed in a way that’s more aligned with your interests.

If your 403(b) isn’t subject to ERISA then there are fewer safeguards in place and your 403(b) may contain products that are a better deal for the salesperson than for you. You’re a little more on your own without ERISA protection. So if you have a 403(b) plan that is not covered by ERISA and you are being sold things like annuities and insurance under the plan, than you may want to be cautious.

Don’t assume that a 403(b) plan that isn’t covered by ERISA is looking out for your retirement needs.

How To Invest In a 403(b) Plans

If you are looking to save for retirement, and are presented with a range of Exchange Traded Funds (ETFs) in your 403(b) it can be confusing. Often picking a target-date fund that is within 5 years of your estimated retirement date can be a reasonable choice. This fund should hold a mix of stocks, bonds and other assets that is intended to grow if retirement is a long way off, and then gradually moves into safer assets as retirement nears.

Of course, there’s no guarantee you’ll see great investment performance, but historically speaking over decades such an investment approach has seen relatively robust returns. Again, do check the fees (the expense ratio) on the fund. Ideally you want to be paying 0.5% or less. That might seem like a small number, but over time it can really add up. For example, with retirement savings of a half a million, a 0.5% fee is $2,500 a year or $75,000 total if you have 30 years until retirement.

Picking Your Own Funds In A 403(b)

If you need to pick your own funds, then it gets a little more complicated. Generally a mix of a diversified international low-cost stock fund, with thousands of individual stocks, and a diversified bond fund is not a bad place to start. Your exact mix of stocks and bonds will depend on your risk tolerance and time to retirement. 60% stocks and 40% bonds is a fairly generic mix. You can increase the weighting to stocks to increase potential long-term return, though returns may be more volatile. You can also increase the weighting to bonds to make your returns more predictable, but you may also see lower growth over the long term. Again, lower fee funds are generally a better choice for similar assets.

Employer Matching

A final benefit to note of 403(b) plans is employer contribution matching. If your employer is willing to match your retirement savings up to certain level, then that’s often a good deal. This is basically an additional benefit from your employer, and even if your 403(b) isn’t great, then saving up to the employer matching level may be worth considering.

Early Withdrawals and Catch Up Contributions

403(b) plans can also be more flexible than 401(k) plans. One helpful aspect can be early withdrawals in 403(b) plans. For 401(k)s it can be tricky or expensive to access your funds before retirement. For 403(b)s getting at your money can be easier. This doesn’t mean that you should do so. Generally retirement saving is best accessed once you are retired, but knowing that you can access your money if you need to is a helpful fallback option.

Secondly, there are generally limits to how much you can contribute to a 403(b) plan, but as retirement nears you can make additional catch up contributions if you qualify. If you have a robust 403(b) plan, this can be a good way to boost your savings. This applies to 401(k) plans too.

So a 403(b) plan isn’t too different to a 401(k) plan. Often the general structure of the plan and savings options can be similar. However, do look out for insurance and annuity products, because these may not be the best way for you to save for retirement depending on your circumstances and especially if you 403(b) plan isn’t covered by ERISA.