When you participate in a 403(b) plan, you defer pre-tax earnings to your account every pay period, typically by designating a percentage of what you earn. The deferred earnings aren't included in the gross income your school system reports to the IRS, which actually helps you save by reducing the income tax you owe for the year.
There is an annual cap on 403(b) contributions imposed by the federal government. That limit is $18,500 in 2018, plus $6,000 in catch-up contributions if you're 50 or older. You can contribute any amount up to that limit.
403(b): The Mechanics
Since the salary deferral is handled automatically, making the contribution is easy. What may be harder is selecting the investments for your account. While you may be limited to just two types of investments — mutual funds and annuities — there may be a mind-numbing variety of those types. In Texas, 73 financial companies, mostly insurers, offer more than 9,000 distinct investment products that qualify for inclusion in 403(b) plans.
Not all districts provide a tailored menu of investment options, so it can be difficult to find a simple, low-cost investment. Annuities, which often carry high fees and surrender charges, continue to dominate the list of investment products available through 403(b) plans. The complexity of the Texas 403(b) landscape can complicate your decision making and result in choices that don't help you save in the most effective manner.
Should You Enroll?
Should you be participating in your district's 403(b) plan? That's a decision you need to make, based on a careful consideration of both the advantages and potential drawbacks.
On the plus side are several things you're already aware of:
Your contributions reduce your current taxable income and the income tax you owe
Investing regularly helps you build your account balance
Tax deferral on your contributions and earnings allows your savings to compound faster than they would in a taxable account since you don't have to withdraw money to pay taxes
There may be drawbacks, however:
- Investment choice may be limited or confusing
- Fees may be higher than average
- Withdrawals must start at retirement